UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549











Form 10-Q











x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the quarterly period ended June 30, 2011





 ̈
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the transition period from ________ to ________





Commission file number   000-51006





HARBIN ELECTRIC, INC.


(Exact name of registrant as specified in its charter)





Nevada
98-0403396(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)





No. 9 Ha Ping Xi Lu, Ha Ping Lu Ji Zhong Qu


Harbin Kai Fa Qu, Harbin, People’s Republic of China 150060


(Address of principal executive offices) (Zip Code)





Telephone: 86-451-86116757


(Registrant’s telephone number, including area code)





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No  ̈





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ̈  No ̈





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.





Large accelerated filer  ̈
Accelerated filerxNon-accelerated filer (Do not check if a smaller reporting company) ̈
Smaller reporting company  ̈





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ̈  Nox





APPLICABLE ONLY TO CORPORATE ISSUERS





State the number of shares outstanding of each of the issuer’s classes of common equity, as of August 9, 2011: 31,434,168 shares of common stock, par value $0.00001 per share.





TABLE OF CONTENTS





PagePart I. Financial InformationItem 1. Financial Statements

3Consolidated Balance Sheets As of June 30, 2011 (Unaudited) and December 31, 2010

3Consolidated Statements of Operations and Other Comprehensive Income (Loss) For the Three Months and Six Months Ended June 30, 2011 and 2010 (Unaudited)

4Consolidated Statements of Changes in Equity (Unaudited)

5Consolidated Statements of Cash Flows For the Six Months Ended June 30, 2011 and 2010 (Unaudited)

6Notes to the Consolidated Financial Statements (Unaudited)

7Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

35Item 3. Quantitative and Qualitative Disclosures About Market Risk

45Item 4. Controls and Procedures

45Part II. Other InformationItem 1. Legal Proceedings

46Item 1A. Risk Factors

47Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

54Item 3. Defaults Upon Senior Securities

54Item 4. (Removed and Reserved)

54Item 5. Other Information

54Item 6. Exhibits

54Signatures

55Index to Exhibits

56




2


PART I. FINANCIAL INFORMATION





Item 1. Financial Statements (Unaudited)


HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 CONSOLIDATED BALANCE SHEETS
 AS OF JUNE 30, 2011 AND DECEMBER 31, 2010
 
 June 30,


December 31,2011


2010(Unaudited)ASSETSCURRENT ASSETS:Cash and cash equivalents

$
87,578,920


$
98,753,870Restricted cash


17,566,185



1,061,900Notes receivable


9,860,951



1,845,883Accounts receivable, net


100,158,684



85,899,332Inventories, net


61,795,604



62,843,556Other assets, current


3,915,991



2,501,695Advances on inventory purchases


20,986,377



15,893,866Total current assets


301,862,712



268,800,102PLANT AND EQUIPMENT, net


201,878,629



173,074,138OTHER ASSETS:Debt issuance costs, net


413,470



496,804Advances on plant and equipment purchases


36,624,941



48,830,831Advances on intangible assets


27,198,715



3,645,361Goodwill


56,005,824



54,919,738Other intangible assets, net


22,655,995



23,147,079Other assets, non-current


3,738,955



1,403,326Total other assets


146,637,900



132,443,139Total assets

$
650,379,241


$
574,317,379LIABILITIES AND SHAREHOLDERS' EQUITYCURRENT LIABILITIES:Notes payable - short term

$
36,895,950


$
2,123,800Accounts payable


23,884,229



26,881,540Short term loans


36,936,172



29,490,480Customer deposits


12,450,791



14,621,882Accrued liabilities and other payables


16,465,608



17,934,047Taxes payable


10,720,587



8,205,807Amounts due to original shareholders


773,500



758,500Total current liabilities


138,126,837



100,016,056LONG TERM LIABILITIES:Long term loans


50,470,000



50,070,000Warrant liability


1,394,418



1,526,530Total liabilities


189,991,255



151,612,586COMMITMENTS AND CONTINGENCIESSHAREHOLDERS' EQUITY:Common Stock, $0.00001 par value, 100,000,000 shares authorized, 31,250,820 shares issued and outstanding as of June 30, 2011 and December 31, 2010


312



312Paid-in-capital


218,434,937



218,212,343Retained earnings


160,380,410



136,149,513Statutory reserves


36,866,080



33,129,367Accumulated other comprehensive income


41,833,399



32,360,515Total shareholders' equity


457,515,138



419,852,050NONCONTROLLING INTERESTS


2,872,848



2,852,743Total liabilities and shareholders' equity

$
650,379,241


$
574,317,379
 
 The accompanying notes are an integral part of these consolidated financial statements.
 
 3
 
 HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME (LOSS)
 FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010
 (Unaudited)
 
 Three Months Ended June 30,


Six Months Ended June 30,2011


2010


2011


2010REVENUES

$
131,401,787


$
105,435,970


$
235,231,211


$
210,921,127COST OF SALES


95,197,678



70,103,783



168,823,314



139,846,870GROSS PROFIT


36,204,109



35,332,187



66,407,897



71,074,257RESEARCH AND DEVELOPMENT EXPENSE


947,674



362,783



4,826,202



956,978SELLING, GENERAL AND  ADMINISTRATIVE EXPENSES


13,798,547



6,886,054



23,871,929



14,302,812INCOME FROM OPERATIONS


21,457,888



28,083,350



37,709,766



55,814,467OTHER EXPENSE (INCOME)Other income, net


(2,389,536
)


(1,326,675
)


(3,510,737
)


(2,445,961
)Interest expense, net


1,259,236



977,858



3,183,186



2,624,781Loss from disposal of subdivision


-



623,158



-



623,158Change in fair value of warrants


(565,867
)


(1,657,457
)


(132,112
)


(1,423,379
)Total other  expense, net


(1,696,167
)


(1,383,116
)


(459,663
)


(621,401
)INCOME BEFORE PROVISION FOR INCOME TAXES


23,154,055



29,466,466



38,169,429



56,435,868PROVISION FOR INCOME TAXES


5,986,251



3,790,892



10,181,684



7,854,253NET INCOME BEFORE NONCONTROLLING INTEREST


17,167,804



25,675,574



27,987,745



48,581,615LESS: NET INCOME  ATTRIBUTABLE TO NONCONTROLLING INTEREST


5,866



770



20,135



2,353,123NET INCOME ATTRIBUTABLE TO CONTROLLING INTEREST


17,161,938



25,674,804



27,967,610



46,228,492OTHER COMPREHENSIVE INCOME (LOSS)Foreign currency translation adjustment


7,024,063



1,320,473



9,472,884



1,412,069Foreign currency translation adjustment attributable to noncontrolling interest


(30
)


611



(30
)


(191
)COMPREHENSIVE INCOME

$
24,185,971


$
26,995,888


$
37,440,464


$
47,640,370EARNINGS PER SHAREBasicWeighted average number of shares


31,250,820



31,067,471



31,250,820



31,067,471Earnings per share before noncontrolling interest

$
0.55


$
0.83


$
0.90


$
1.56Earnings per share attributable to controlling interest

$
0.55


$
0.83


$
0.89


$
1.49Earnings per share attributable to noncontrolling interest

$
-


$
-


$
-


$
(0.08
)DilutedWeighted average number of shares


31,351,139



31,343,306



31,337,330



31,348,563Earnings per share before noncontrolling interest

$
0.55


$
0.82


$
0.89


$
1.55Earnings per share attributable to controlling interest

$
0.55


$
0.82


$
0.89


$
1.47Earnings per share attributable to noncontrolling interest

$
-


$
-


$
-


$
(0.08
)
 
 The accompanying notes are an integral part of these consolidated financial statements.
 
 4
 
 HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
 
 Common stock


Additional


Retained earnings


Accumulated otherPar


paid-in


Unrestricted


Statutory


comprehensive


NoncontrollingShares


value


capital


earnings


reserves


income


interest


TotalBALANCE, January 1, 2010


31,067,471


$
310


$
218,094,374


$
69,594,111


$
22,869,423


$
18,638,299


$
21,299,841


$
350,496,358Amortization of stock compensation










509,338



















509,338Net income














46,228,492











2,353,123



48,581,615Adjustment to statutory reserve














(5,044,288
)


5,044,288











-Deconsolidation of subsidiaries






















23



(1,604,613
)


(1,604,590
)Acquisition of noncontrolling interest










(5,387,208
)










711



(22,134,423
)


(27,520,920
)Foreign currency translation gain






















1,412,069



(191
)


1,411,878BALANCE, June 30, 2010 (Unaudited)


31,067,471



310



213,216,504



110,778,315



27,913,711



20,051,102



(86,263
)


371,873,679Amortization of stock compensation










485,441



















485,441Exercise of stock warrants at $10.84


183,349



2



4,510,398



















4,510,400Noncontrolling interest in acquiree






























-Net income














30,586,854











79,288



30,666,142Adjustment to statutory reserve














(5,215,656
)


5,215,656











-Increase in noncontrolling interest


























2,882,353



2,882,353Foreign currency translation gain






















12,309,413



(22,635
)


12,286,778BALANCE, December 31, 2010


31,250,820



312



218,212,343



136,149,513



33,129,367



32,360,515



2,852,743



422,704,793Amortization of stock compensation










222,594



















222,594Net income














27,967,610











20,135



27,987,745Adjustment to statutory reserve














(3,736,713
)


3,736,713











-Foreign currency translation gain






















9,472,884



(30
)


9,472,854BALANCE, June 30, 2011 (Unaudited)


31,250,820


$
312


$
218,434,937


$
160,380,410


$
36,866,080


$
41,833,399


$
2,872,848


$
460,387,986
 
 The accompanying notes are an integral part of these consolidated financial statements.
 
 5
 
 HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010
 (Unaudited)
 
 Six Months Ended June 30,2011


2010CASH FLOWS FROM OPERATING ACTIVITIES:Net income attibutable to noncontrolling interest

$
20,135


$
2,353,123Net income attibutable to controlling interest


27,967,610



46,228,492Consolidated net income


27,987,745



48,581,615Adjustments to reconcile net income to cash provided by (used in) operating activities:Depreciation


5,061,037



3,829,181Amortization of intangible assets


897,937



753,764Amortization of debt issuance costs


83,334



281,936Amortization of debt discount


-



1,223,276Provision for (recovery of) receivables


1,915,982



(29,116
)Write off of advances on inventory purchases


2,478,661



-Provision for (recovery of) inventory reserve


695,277



(387,200
)Share-based compensation


222,594



509,338Loss on disposal of equipment


45,418



69,119Change in fair value of warrants


(132,112
)


(1,423,379
)Loss on sale of discontinued operations


-



623,158Foreign exchange loss


400,000



-Change in operating assets and liabilitiesNotes receivable


(3,531,852
)


770,358Accounts receivable, net


(14,356,056
)


(2,750,252
)Inventories, net


1,632,996



(6,358,437
)Advances on inventory purchases


(7,232,161
)


(1,498,028
)Other assets, current


(1,086,402
)


2,328,104Other assets, non-current


(2,011,882
)


125,988Accounts payable


7,301,489



9,370,961Customer deposits


(2,431,625
)


(2,803,473
)Accrued liabilities and other payables


(1,836,200
)


(4,798,093
)Taxes payable


2,325,131



719,344Net cash  provided by operating activities


18,429,317



49,138,164CASH FLOWS FROM INVESTING ACTIVITIES:Payment for advances on intangible assets


(23,208,049
)


-Payment for advances on equipment purchases


(5,692,232
)


(10,386,470
)Purchase of intangible assets


(10,634
)


(110,507
)Purchase of plant and equipment


(3,604,343
)


(1,637,564
)Disposal of plant and equipment


77,931



90,892Additions to construction-in-progress


(8,444,793
)


(28,558,099
)Payment to original shareholders for acquisition


-



(27,946,571
)Payment to acquire noncontrolling interests


-



(26,550,890
)Deconsolidation of cash held in disposed subdivisions


-



(602,948
)Proceeds from sale of controlling interests in subsidiaries


-



718,781Net cash used in investing activities


(40,882,120
)


(94,983,376
)CASH FLOWS FROM FINANCING ACTIVITIES:Increase in restricted cash


(16,291,495
)


(1,543,179
)Payment on notes payable


(611,600
)


(3,800,000
)Proceeds from notes payable-short term


21,263,770



4,271,647Payment on notes payable-short term


(2,140,600
)


(3,080,524
)Proceeds from short term loans-bank


26,451,700



6,307,670Repayment of short term loans-bank


(19,571,200
)


(9,094,780
)Net cash provided by (used in) financing activities


9,100,575



(6,939,166
)EFFECTS OF EXCHANGE RATE CHANGE ON CASH


2,177,278



157,179DECREASE IN CASH


(11,174,950
)


(52,627,199
)Cash and cash equivalents, beginning of period


98,753,870



92,902,400Cash and cash equivalents, end of period

$
87,578,920


$
40,275,201
 
 The accompanying notes are an integral part of these consolidated statements.
 
 6
 HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Note 1 - Nature of Business
 
 Harbin Electric, Inc. (the “Company” or “Harbin Electric”) is a Nevada Corporation, incorporated on July 9, 2003. Through its subsidiaries, the Company designs, develops, engineers, manufactures, sells and services a wide array of electric motors including linear motors, specialty micro-motors, and industrial rotary motors, with focus on innovation, creativity, and value-added products.  Products are sold in China and to certain international markets.
 
 Recent development
 
 On June 19, 2011, the Company entered into an Agreement and Plan of Merger, dated June 19, 2011 (“Merger Agreement”), with Tech Full Electric Company Limited, a Cayman Islands exempted company with limited liability, wholly owned indirectly by Mr. Tianfu Yang, the Company’s Chairman and Chief Executive Officer (“Parent”) and Tech Full Electric Acquisition, Inc., a Nevada corporation and a wholly-owned subsidiary of Parent (“Merger Sub”).
 
 Pursuant to the Merger Agreement, upon the terms and subject to the conditions thereof, at the effective time of the merger, Merger Sub will be merged with and into the Company, the Company will become a wholly-owned subsidiary of the Parent and each of the Company’s shares of common stock issued and outstanding immediately prior to the effective time of the merger (the “Shares”) will be converted into the right to receive $24.00 in cash without interest, except for Shares owned by Parent and Merger Sub (including shares to be contributed to Parent by Mr. Tianfu Yang, affiliates of Abax Global Capital (“Abax”) and certain of the Company’s employees and officers (collectively, the “Purchasing Group”) prior to the effective time of the merger pursuant to a contribution agreement between Parent, each member of the Purchasing Group and Tianfu Investments Limited, a Cayman Islands company directly owning 100% of the equity interest in Parent).
 
 The Merger Agreement contains customary termination provisions for both the Company and Parent. If the Merger Agreement is terminated under certain circumstances, the Company will be required to pay Parent a termination fee of $22,500,000. If the Merger Agreement is terminated under certain other circumstances, Parent will be required to pay the Company a termination fee equal to $30,000,000.
 
 The merger is currently expected to close in the fourth quarter of this year, and is subject to customary closing conditions as well as approval and adoption of the Merger Agreement by the Company’s shareholders (including the affirmative approval of the holders of a majority in combined voting power of the outstanding Shares not owned by the Purchasing Group). If completed, the merger will result in the Company becoming a privately-held company, and the Shares will no longer be listed on any public market. Accordingly, no assurance can be given that the merger will be completed.
 
 Note 2 - Summary of Significant Accounting Policies
 
 Basis of presentation
 
 The consolidated financial statements of Harbin Electric Inc. reflect the activities of the following subsidiaries.  All material intercompany transactions have been eliminated.
 Place incorporated

Ownership

percentageAdvanced Electric Motors, Inc. (“AEM”)

Delaware, USA

100
%Harbin Tech Full Electric Co., Ltd. (“HTFE”)

Harbin, China

100
%Advanced Automation Group, LLC (“AAG”)

Delaware, USA

51
%Advanced Automation Group Shanghai Co., Ltd. (“SAAG”)

Shanghai, China

51
%Shanghai Tech Full Electric Co., Ltd. (“STFE”)

Shanghai, China

100
%Weihai Tech Full Simo Motor Co., Ltd. (“Weihai”)

Weihai, China

100
%Xi’an Tech Full Simo Motor Co., Ltd. (“Simo Motor”)

Xi’an, China

100
%
 
 7
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 The accompanying consolidated financial statements include the accounts of all directly and indirectly owned subsidiaries listed above.
 
 The interim unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP, for interim financial information and with the instructions to Securities and Exchange Commission, or SEC, Form 10-Q and Article 10 of SEC Regulation S-X and consistent with the accounting policies stated in the Company’s 2010 Annual Report on Form 10-K. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, these financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended December 31, 2010, included in our Annual Report on Form 10-K filed with the SEC.
 
 The interim consolidated financial statements included herein are unaudited; however, they contain all normal recurring accruals and adjustments that, in the opinion of management, are necessary to present fairly our consolidated financial position as of June 30, 2011 and December 31, 2010, and our consolidated results of operations for the three months and six months ended June 30, 2011 and 2010 and cash flows for the six months ended June 30, 2011 and 2010. The results of operations for the three months and six months ended June 30, 2011 are not necessarily indicative of the results to be expected for future quarters or the full year.
 
 Use of estimates
 
 The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the reported amounts of assets, liabilities, revenue and expenses, and disclosures about contingent assets and liabilities. Such estimates and assumptions by management affect accrued expenses, the valuation of accounts receivable, inventories, and long-lived assets, legal contingencies, lives of plant and equipment, lives of intangible assets, business combinations, goodwill, calculation of warranty accruals, taxes, share-based compensation and others.
 
 Although the Company regularly assesses these estimates, actual results could materially differ. The Company bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances.
 
 Foreign currency transactions
 
 Our reporting currency is the US dollar.  The functional currency of PRC subsidiaries is the Chinese Renminbi (“RMB”). Our results of operations and financial position of the PRC subsidiaries are translated to United States dollars using the end of period exchange rates as to assets and liabilities and weighted average exchange rates as to revenues, expenses and cash flows. Capital accounts are translated at their historical exchange rates when the capital transaction occurred. The resulting currency translation adjustments are recorded as a component of accumulated other comprehensive income (loss) within stockholders’ equity.  As a result, translation adjustments amounts related to assets and liabilities reported on the consolidated statement of cash flows will not necessarily agree with changes in the corresponding consolidated balances on the balance sheet. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.
 
 Translation adjustments resulting from this process amounted to a gain of $7,024,063 and $1,320,473 for the three months ended June 30, 2011 and 2010, respectively. Translation adjustments resulting from this process amounted to a gain of $9,472,884 and $1,412,069 for the six months ended June 30, 2011 and 2010, respectively. The balance sheet amounts with the exception of equity at June 30, 2011 and December 31, 2010 were translated at 6.46 RMB to $1.00 and 6.59 RMB to $1.00, respectively.  The equity accounts were stated at their historical exchange rate.  The average translation rates applied to the revenues, expenses and cash flows statement amounts for the six months ended June 30, 2011 and 2010 were 6.54 RMB to $1.00, and 6.82 RMB to $1.00, respectively.
  8
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Transaction loss of $272,808 and $35,796 were recognized which were included in the other income for the three months ended June 30, 2011 and 2010, respectively. Transaction loss of $465,541 and $38,478 were recognized which were included in the other income for the six months ended June 30, 2011 and 2010, respectively.
 
 Concentration of risks
 
 The Company considers all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents, for cash flow statement purposes.  Cash includes cash on hand and demand deposits in accounts maintained with state owned banks within the PRC and with banks in the United States. The Company maintains balances at financial institutions which typically exceed Federal Deposit Insurance Corporation insured limits for the banks located in the United States. Balances at financial institutions or state owned banks within the PRC are not insured. As of June 30, 2011 and December 31, 2010, the Company had deposits in excess of federally insured limits totaling $87,005,250 and $98,989,404, respectively. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant risks on its cash in bank accounts.
 
 No customer accounted for more than 10% of the net revenue for the three months and six months ended June 30, 2011 and 2010.
 
 No vendor accounted for more than 10% of the raw material purchases for the three months and six months ended June 30, 2011 and 2010.
 
 The Company's operations are carried out in the PRC. Accordingly, the Company's business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC's economy. The Company's operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in the North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company's results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
 
 Restricted cash
 
 Restricted cash represents amounts set aside by the Company in accordance with the Company’s debt agreements with certain financial institutions.  These cash amounts are designated for the purpose of paying down the principal amounts owed to the financial institutions, and these amounts are held at the same financial institutions with which the Company has debt agreements in the PRC.  Due to the short-term nature of the Company’s debt obligations to these banks, the corresponding restricted cash balances have been classified as current in the consolidated balance sheets.
 
 Notes receivable
 
 Notes receivable arose from sale of goods and represent commercial drafts issued by customers to the Company and were guaranteed by banks of the customers.  Notes receivables are interest-free with maturity dates of three or six months from date of issuance. The Company has the ability to submit a request for payment to the customer’s bank earlier than the scheduled payment date, but in such a case will incur an interest charge and a processing fee.
 
 Accounts receivable, net
 
 Accounts receivable are presented net of an allowance for bad debts account. The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. The estimated loss rate is based on the Comany’s historical loss experience and also contemplates current market conditions. Delinquent account balances are written-off after management has determined that the likelihood of collection is not probable, and known bad debts are written off against allowance for doubtful accounts when identified.
  9
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Inventories, net
 
 Inventories are valued at the lower of cost or market value, as determined on a first-in, first-out basis, using the weighted average method. Management compares the cost of inventories with the market value and an allowance is made for writing down the inventories to its market value, if lower than cost. On an ongoing basis, inventories are reviewed for potential write-down for estimated obsolescence or unmarketable inventories equal to the difference between the costs of inventories and the estimated net realizable value based upon forecasts for future demand and market conditions. When inventories are written-down to the lower of cost or market, they are not marked up subsequently based on changes in underlying facts and circumstances.  Inventories are composed of raw material for manufacturing electrical motors, work in process and finished goods within the Company’s warehouse premise or consigned at a customer site. The inventory allowance is made when the inventory’s market value is lower than the cost. The recovery of the reserve is only made through sale or disposition of such inventory items.
 
 Plant and equipment, net
 
 Plant and equipment are stated at cost, net of depreciation. Expenditures for maintenance and repairs are charged to earnings as incurred; additions, renewals and betterments are capitalized. When assets are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation of plant and equipment is provided using the straight-line method for substantially all assets with estimated lives as follows:
 
 Estimated Useful LifeBuildings

20-40 yearsVehicle

5-10 yearsOffice equipment

5-6 yearsProduction equipment

10-12 years
 
 Construction in progress represents the costs incurred in connection with the construction of buildings or new additions to the Company’s plant facilities.  No depreciation is provided for construction in progress until such time as the assets are completed and placed into service. Maintenance, repairs and minor renewals are charged directly to expense as incurred. Major additions and betterment to buildings and equipment are capitalized. Interest incurred during construction is capitalized into construction in progress. All other interest is expensed as incurred.
 
 The Company recognizes an impairment loss when estimated cash flows generated by those assets are less than the carrying amounts of the asset. Based on management review, the Company believes that there were no impairments as of June 30, 2011.
 
 Goodwill and other intangible assets
 
 Goodwill – the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed is recognized as goodwill.  Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis in the fourth quarter or more frequently if there are indications of impairment. For purposes of the goodwill impairment test, a two-step test is used to identify the potential impairment and to measure the amount of goodwill impairment, if any. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.
  10
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 General intangibles other than goodwill
 
 Intangible assets that are acquired individually or as part of a group of assets, other than those acquired in a business combination are initially recorded at their fair value. The cost of a group of assets acquired in a transaction is allocated to the individual assets based on their relative fair values. Goodwill does not arise in such a transaction. Intangible assets that are acquired in a business combination are accounted for in accordance with ASC Topic 805,Business Combinations. The costs of intangible assets that are developed internally, as well as the costs of maintaining or restoring intangible assets that have indeterminate lives or that are inherent in a continuing business and related to the entity as a whole, are expensed as incurred.
 
 The accounting for intangible assets, other than goodwill, subsequent to acquisition is based on the asset’s useful life. The useful life of the intangible asset is the period over which the asset is expected to contribute directly or indirectly to the entity’s future cash flows. An asset for which no legal, regulatory, contractual, competitive, economic, or other factors limit its useful life is considered to have an indefinite useful life.
 
 The Company evaluates intangible assets for impairment, at least annually and whenever events or changes in circumstances indicate that the assets might be impaired.  We perform our annual impairment test in the fourth quarter.
 
 The Company’s impairment test consists of a comparison of the fair value of the intangible asset with its carrying amount. If the carrying amount of an intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to the excess.  As of June 30, 2011, management believes there was no impairment.
 
 Accounting for long-lived assets
 
 Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We assess the recoverability of the assets based on the undiscounted future cash flow the assets are expected to generate and recognize an impairment loss when estimated undiscounted future cash flow expected to result from the use of the asset plus net proceeds expected from disposition of the asset, if any, are less than the carrying value of the asset. When we identify an impairment, we reduce the carrying amount of the asset to its estimated fair value based on a discounted cash flow approach or, when available and appropriate, to comparable market values.  As of June 30, 2011, management believes there was no impairment.
 
 Notes payable
 
 In general, the short term notes are bank acceptance notes payable issued by local banks in China that entitle the Company’s suppliers to receive the full face amount from the issuing banks. In China, this is a very common low cost financial instrument used to pay suppliers.
 
 Our bank acceptance notes payable represent short-term notes payable issued by Chinese banks in connection with the Company’s purchases that entitle the Company’s suppliers to receive the full face amount from the financial institutions at maturity, which range six to twelve months from the date of issuance. The notes payable were secured by the Company’s restricted cash deposited with issuing banks. All the bank acceptance notes are subject to bank charges of 0.05% of the principal as a commission on each loan transaction. The amount borrowed is entered in the accounting records by increasing cash or as payments to vendors and increasing notes payable.  When the note is repaid, the difference between the carrying amount of the note and the cash necessary to repay that note is reported as interest expense.
 
 Stock-based compensation
 
 We record share-based compensation expense based upon the grant date fair value of share-based awards. The value of the award is principally recognized as expense ratably over the requisite service periods. We use the Black-Scholes Merton (“BSM”) option-pricing model, which incorporates various assumptions including volatility, expected life and interest rates to determine fair value. The Company’s expected volatility assumption is based on the historical volatility of Company’s stock. The expected life assumption is primarily based on the simplified method of the terms of the options. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
  11
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 The Company is required to measure the cost of the equity instruments issued in exchange for the receipt of goods or services from other than employees at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably determinable. The value of equity instruments issued for consideration other than employee services is determined on the earlier of a performance commitment or completion of performance by the provider of goods or services.
 
 Stock compensation expense is recognized based on awards expected to vest.  GAAP requires forfeitures to be estimated at the time of grant and revised in subsequent periods, if necessary, when actual forfeitures differ from those estimates.  There were no estimated forfeitures as the Company has a short history of issuing options and the actual forfeitures during the history of issuing options were minimal.
 
 Revenue recognition
 
 The Company recognizes sales when title and risk of ownership are passed to the customer (which is at the date of shipment), when a formal arrangement exists, the price is fixed or determinable, no other significant obligations exist and collectability is reasonably assured. For products that are required to be examined by customers, sales revenue is recognized after the customer examination period has passed. Payments received before all of the relevant criteria for revenue recognition are satisfied, are recorded as customer deposits.
 
 In addition, revenue recognition could be negatively impacted by returns. For our linear motor and specialty micro-motor businesses, our products are custom products which are customer specific, and no returns are allowed. We warrant our product for repair, only in the event of defects for two years from the date of shipment.  We charge such costs to cost of goods sold. For our industrial rotary motor business, our products are standardized products and returns are allowed within three days upon receipt of products by customers. We provide product warranty for repair one year from the date of shipment. Historically, the returns and defects have not been material. Should returns increase in the future it would be necessary to adjust the estimates, in which case recognition of revenues could be delayed.
 
 The Company also provides after-sale services to our customers. Service revenue is recognized as services are rendered, the customers have approved the completion of the services and invoices have been issued and collectability is reasonably assured. Customer billings for services not yet rendered are deferred and recognized as revenue as the services are rendered and the associated deferred revenue is included in current liabilities or long-term liabilities, as appropriate.
 
 The Company recognizes revenues with regards to the sales of consigned inventories when the title and risks of ownership have been transferred to customers, customers provide persuasive evidence to notify the Company, and upon receipt of the notification form from customers. The Company also performs periodic inventory counts to confirm the inventory quantities held on consignment.
 
 Customers who purchase industrial rotary motors are divided into two major categories: distributors and non-distributors. Non-distributors consist of OEM users, traders and end users. Except for the annual sales target for distributors, the sales arrangements are the same with distributors and non-distributors.
 
 Distributors are committed to annual purchase targets and may be entitled to a sales rebate. The Company periodically provides incentive offers to its distributors to encourage purchases. Such offers include inducement offers (e.g., offers of future discounts subject to meeting the customer’s annual purchase target), and other similar offers. Inducement offers, when accepted by customers, are treated as a reduction to purchase price based on estimated future redemption rates. Redemption rates are estimated using the Company’s historical experience for similar inducement offers. Inducement offers are presented as a net amount in “net sales.”
  12
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Shipping and handling costs are included in selling, general and administrative costs and totaled $1,294,825 and $1,212,761 for the three months ended June 30, 2011 and 2010, respectively. Shipping and handling costs totaled $2,754,193 and $2,045,176 for the six months ended June 30, 2011 and 2010, respectively.
 
 Income taxes
 
 The Company utilizes the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized.  GAAP also requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. As of January 1, 2007, income tax positions must meet a more-likely-than-not recognition threshold to be recognized.  A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
 
 Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.  Deferred tax assets of $314,935 and $377,727 mainly due to the temporary differences of commission expenses between the financial statement and tax basis were recorded at June 30, 2011 and December 31, 2010, respectively. The deferred tax assets (see Note 12 for more discussion) were included in the Consolidated Balance Sheets under other assets, net. The deferred tax activity consisted of the following:
 
 AmountDeferred tax assets at January 1, 2010

$
-Additions to deferred tax assets


-Decrease of deferred tax assets


-Effect of foreign currency translation


-Deferred tax assets at June 30, 2010 (unaudited)


-Additions to deferred tax assets


368,365Decrease of deferred tax assets


-Effect of foreign currency translation


9,362Deferred tax assets at December 31, 2010


377,727Additions to deferred tax assets


112,410Decrease of deferred tax assets


(182,672
)Effect of foreign currency translation


7,470Deferred tax assets at June 30, 2011 (unaudited)

$
314,935
 
 Penalties and interest incurred related to underpayment of income tax are classified as income tax expense in the year incurred.  No significant penalties or interest relating to income taxes have been incurred during the three and six months ended June 30, 2011 and 2010.  GAAP also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures and transition.
 
 The charge for taxation is based on the results for the reporting period as adjusted for items, which are non-assessable or non-deductible.  It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.
  13
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 The Company’s operating subsidiaries located in PRC are subject to PRC income tax. Under the Income Tax Laws of PRC, a company is generally subject to income tax at an effective rate of 25% on income reported in the statutory financial statements after appropriated tax adjustments. The PRC government provides reduced tax rates for productive foreign investment enterprises in the Economic and Technological Development Zones and for enterprises engaged in production or business operations in the Special Economic Zones or in certain industries.  These preferential tax rates are generally graduated, starting at 0% and increasing to the standard EIT rate of 25% over time. HTFE was granted a 10% preferential tax rate from 2008 to 2010 due to its location in a specially designated economic region. This 10% preferential tax rate expired on December 31, 2010. While applying for the next level of 15% preferential tax treatment, HTFE is currently using 25% standard income tax rate until the application is approved. STFE was income tax exempt in 2008 and 2009 and was granted a preferential income tax rates of 11% in 2010 and 12% in 2011 due to its location in an economic development zone.  Simo Motor enjoyed a 15% preferential tax rate in 2009 and 2010 due to its location in the Province of Shaanxi which is in the mid-west region of China, and qualified for the government’s “Go-West” program. This “Go-West” preferential tax rate expired on December 31, 2010. However, in 2011 Simo Motor also qualifies for a 15% preferential tax rate applying to enterprises in high/new technology industries designated for special support by the State. Weihai has been subject to 25% standard income tax rate.
 
 The Company’s subsidiaries were subject to the following tax rates for the three and six months ended June 30:
 
 2011

(Unaudited)


2010

(Unaudited)Subsidiaries

Income

Tax

Exemption


Effective

Income

Tax Rate


Income

Tax

Exemption


Effective

Income

Tax RateHTFE


-



25
%


15
%


10
%Weihai


-



25
%


-



25
%STFE


13
%


12
%


14
%


11
%Simo Motor


10
%


15
%


10
%


15
%
 
 The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the three months ended June 30:
 
 2011

(Unaudited)


2010

(Unaudited)U.S. Statutory rates


34.0
%


34.0
%Foreign income not recognized in USA


-34.0



-34.0China income taxes


25.0



25.0Tax exemption


-3.4



-9.4Other items (a)


4.3



-2.7Effective income taxes


25.9
%


12.9
%
 
 (a)  The 4.3% represents the $4,600,793 of expenses incurred by the Company, and its US subsidiaries AEM and AAG that are not subject to PRC income tax for the three months ended June 30, 2011.
 
 The (2.7%) represents the $787,587 of gain incurred by the Company, and its US subsidiaries AEM and AAG that are not subject to PRC income tax for the three months ended June 30, 2010.
 
  14
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the six months ended June 30:
 
 2011

(Unaudited)


2010

(Unaudited)U.S. Statutory rates


34.0
%


34.0
%Foreign income not recognized in USA


-34.0



-34.0China income taxes


25.0



25.0Tax exemption


-2.6



-11.6Other items (a)


4.3



0.5Effective income taxes


26.7
%


13.9
%
 
 (a)  The 4.3% represents the $7,243,461 of expenses incurred by the Company, and its US subsidiaries AEM and AAG that are not subject to PRC income tax for the six months ended June 30, 2011.
 
 The 0.5% represents the $279,410 of expenses incurred by the Company, and its US subsidiaries AEM and AAG that are not subject to PRC income tax for the six months ended June 30, 2010.
 
 The estimated tax savings for the three months ended June 30, 2011 and 2010 amounted to $950,737 and $3,686,283, respectively. The net effect on earnings per share attributable to controlling interest had the income tax been applied would decrease earnings per share from $0.55 to $0.52 for the three months ended June 30, 2011, $0.83 to $0.71 for the three months ended June 30, 2010.
 
 The estimated tax savings for the six months ended June 30, 2011 and 2010 amounted to $1,159,500 and $6,806,723, respectively. The net effect on earnings per share attributable to controlling interest had the income tax been applied would decrease earnings per share from $0.89 to $0.86 for the six months ended June 30, 2011, $1.49 to $1.27 for the six months ended June 30, 2010.
 
 Harbin Electric, AEM and AAG were organized in the United States and have incurred net operating losses for income tax purposes for the three months and six months ended June 30, 2011.  The net operating loss carry forwards for United States income taxes for Harbin Electric and AEM amounted to approximately $42.0 million which may be available to reduce future years’ taxable income. Management believes that the realization of the benefits from these losses appears uncertain due to the Company’s limited operating history and continuing losses for United States income tax purposes.  Accordingly, the Company has provided a 100% valuation allowance on the deferred tax asset benefit to reduce the asset to zero.  The net change in the valuation allowance for the three months ended June 30, 2011 was an increase of approximately $2.3 million. Management will review this valuation allowance periodically and make adjustments accordingly. AAG started to use the net operating loss carry forwards from previous years in the amount of $168,421 to reduce its taxable income generated in 2011. The remaining carry forwards will expire, if not utilized, in years 2027 through 2030.
 
 The Company has cumulative undistributed earnings of foreign subsidiaries of approximately $298 million as of June 30, 2011, which is included in consolidated retained earnings and will continue to be indefinitely reinvested in international operations.  Accordingly, no provision has been made for U.S. deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if we concluded that such earnings will be remitted in the future.
 
 Value added tax
 
 Sales revenue represents the invoiced value of goods, net of a value-added tax (“VAT”). All of the Company’s products that are sold in the PRC are subject to a Chinese value-added tax at a rate of 17% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing their finished product. The Company recorded VAT Payable and VAT receivable net of payments in the financial statements. The VAT tax return is filed offsetting the payables against the receivables.
  15
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 VAT on sales and VAT on purchases amounted to $23,859,349 and $19,588,639 for the three months ended June 30, 2011, respectively.  VAT on sales and VAT on purchases amounted to $20,075,916 and $13,653,918 for the three months ended June 30, 2010, respectively.  Sales and purchases are recorded net of VAT collected and paid as the Company acts as an agent for the government.
 
 VAT on sales and VAT on purchases amounted to $43,147,929 and $32,438,524 for the six months ended June 30, 2011, respectively.  VAT on sales and VAT on purchases amounted to $38,059,087 and $24,967,631 for the six months ended June 30, 2010, respectively.  Sales and purchases are recorded net of VAT collected and paid as the Company acts as an agent for the government.
 
 Advertising expenses
 The Company expenses the cost of advertising as incurred in selling, general and administrative expenses. The Company incurred $117,268 and $23,662 for the three months ended June 30, 2011 and 2010, respectively.
 
 The Company expenses the cost of advertising as incurred in selling, general and administrative expenses. The Company incurred $149,552 and $56,111 for the six months ended June 30, 2011 and 2010, respectively.
 
 Research and development expenses
 Research and development costs are expensed as incurred.  The costs of material and equipment that are acquired or constructed for research and development activities and have alternative future uses are classified as plant and equipment and depreciated over their estimated useful lives. The Company’s total research and development expenses for the three months ended June 30, 2011 and 2010 are $947,674 and $362,783, respectively. The Company’s total research and development expenses for the six months ended June 30, 2011 and 2010 are $4,826,202 and $956,978, respectively.
 
 In March 2010, the Company entered into a research and development contract with a research institute to develop the linear motor automated control system. The total contracted amount was $4.8 million with a 3-year term. For the six months ended June 30, 2011, $3,544,149 was incurred and expensed as research and development costs.
 
 Noncontrolling interest
 
 The Company owns 100% of Simo Motor. The 0.05% of noncontrolling interest was acquired indirectly from Simo Motor’s subsidiary Qishan Simo Moulding Co, Ltd.  Effective July 1, 2010, 49% of AAG and SAAG was owned by noncontrolling interests, Shelton Technology, LLC, a Michigan limited liability company.
 
 Fair value of financial instruments
 
 The Company measures and reports its financial assets and liabilities on a fair value basis in accordance with ASC Topic 820,“Fair Value Measurements and Disclosures” (“ASC 820”). ASC 820 defines fair value as the price that would be received to sell an asset or the price paid to transfer a liability (the exit price) in the principal and most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 requires the classification of assets and liabilities carried at fair value using a three-tier hierarchy based upon observable and unobservable inputs as follows:
 
 Level 1: Quoted market prices in active markets for identical assets or liabilities
 
 Level 2: Observable market based inputs that are corroborated by market data
 
 Level 3: Unobservable inputs that are not corroborated by market data
  16
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 As of June 30, 2011 and December 31, 2010, the Company has 183,348 warrants outstanding. The fair value of the outstanding warrants was approximately $1.39 million and $1.53 million, respectively.  The Company recognized a total of $565,867 gain and a total of $1,657,457 gain from the change in fair value of the warrants for the three months ended June 30, 2011 and 2010, respectively. The Company recognized a total of $132,112 gain and a total of $1,423,379 gain from the change in fair value of the warrants for the six months ended June 30, 2011 and 2010, respectively.
 
 These common stock purchase warrants do not trade in an active securities market, and as such, we estimate the fair value of these warrants using the BSM using the following assumptions:
 
 June 30, 2011


December 31, 2010(Unaudited)Annual dividend yield


-



-Expected life (years)


1.17



1.67Risk-free interest rate


0.22
%


0.51
%Expected volatility


97
%


61
%
 
 Expected volatility is based primarily on historical volatility. Historical volatility was computed using daily pricing observations for recent periods that correspond to the term of the warrants. We believe this method produces an estimate that is representative of our expectations of future volatility over the expected term of these warrants. We have no reason to believe future volatility over the expected remaining life of these warrants likely to differ materially from historical volatility. The expected life is based on the remaining term of the warrants. The risk-free interest rate is based on U.S. Treasury securities according to the remaining term of the warrants.
 
 Carrying Value

as of

June 30,

2011

Fair Value Measurements at June 30, 2011 Using

Fair Value Hierarchy(Unaudited)

Level 1

Level 2

Level 3Fair value of warrant liabilities

$
1,394,418



$
1,394,418
 
 Other than the warranty liabilities, the Company did not identify any financial assets or liabilities that are required to be presented on the balance sheet at fair value.
 
 Recent accounting pronouncements
 
 In April 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard UpdateNo. 2011-02,Receivables (Topic 310) – A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring, which clarify when a modification or restructuring of a receivable constitutes a troubled debt restructuring. In evaluating whether such a modification or restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that two conditions exist: (1) the modification or restructuring constitutes a concession and (2) the debtor is experiencing financial difficulties. The guidance will be effective for our interim and annual reporting periods beginning after June 15, 2011 and will be applied retrospectively to the beginning of the annual period of adoption. The adoption of this newly issued guidance is not expected to have a material impact on our consolidated financial statements.
 
 In May 2011, FASB issued Fair Value Measurement (Topic 820) — Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs No. 2011-0, which provides additional guidance for fair value measurements. These updates to the ASC or Codification include clarifications regarding existing fair value measurement principles and disclosure requirements, and also specific new guidance for items such as measurement of instruments classified within stockholders’ equity and disclosures regarding the sensitivity of Level 3 measurements to changes in valuation model inputs. These updates to the Codification are effective for interim and annual periods beginning after December 15, 2011. We do not expect the implementation of this guidance to have a material impact on its consolidated financial statements.
  17
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 In June 2011, the FASB issued Comprehensive Income (Topic 220) — Presentation of Comprehensive Income (ASU No. 2011-05), which updates the Codification to require the presentation of the components of net income, the components of other comprehensive income (OCI) and total comprehensive income in either a single continuous statement of comprehensive income or in two separate, but consecutive statements of net income and comprehensive income. These updates do not affect the items reported in OCI or the guidance for reclassifying such items to net income. These updates to the Codification are effective for interim and annual periods beginning after December 15, 2011. We do not expect the implementation of this guidance to have a material impact on its consolidated financial statements.
 
 Reclassifications
 
 Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications have no effect on net income or cash flows.
 
 Note 3 – Disposal of subsidiaries
 
 Effective April 1, 2010, Simo Motor, a PRC subsidiary of the Company, sold its equity interests in its three subsidiaries, Tianjin Simo Electric Co., Ltd. (“Tianjin Simo”), Xi’an Simo Science and Technology Development Co., Ltd. (“Science and Technology”) and Xi’an Simo Imports and Exports Co., Ltd. (“Imports and Exports”), to certain shareholders of these three subsidiaries.  As a result of the foregoing dispositions, Simo Motor no longer owns any of the outstanding equity of these three subsidiaries.
 
 Note 4 – Acquisition of the noncontrolling interests
 
 Effective April 1, 2010, Simo Motor, a PRC subsidiary of the Company, acquired all of the equity interests in its four subsidiaries, Tech Full Lamination Co., Ltd. (“Lamination”), Xi’an Simo A’Da Motor Co., Ltd. (“A’Da Motor”), Xi’an Tech Full Simo Moulds Co., Ltd. (“Moulds”) and Xi’an Tech Full Simo Transportation Co., Ltd. (“Transportation”). As a result of the above acquisitions, Simo Motor now owns 100% of the outstanding equity of these four subsidiaries.
 
 Note 5 – Supplemental disclosure of cash flows
 
 The Company prepares its statements of cash flows using the indirect method as defined under the ASC Topic 230. The following information relates to non-cash investing and financing activities for the three months ended March 31, 2011 and 2010.
 
 Total interest paid amounted to $2,018,579 and $1,513,782 for the six months ended June 30, 2011 and 2010, respectively.
 
 Total income tax paid amounted to $9,021,468 and $7,089,794 for the six months ended June 30, 2011 and 2010, respectively.
 
 For six months ended June 30, 2011, notes receivable in the amount of $16,847, and other receivable in the amount of $664 were used for plant and equipment purchases. Other receivables in the amount of $98,758 were used to increase construction-in-progress. Accounts payables in the amount of $2,028 were reduced against proceeds from disposal of equipment.
 
 For the six months ended June 20, 2011, $12,548,166 was transferred from advanced on equipment purchases to plant and equipment upon the receipt and installation of equipment.
 
 For the six months ended June 30, 2011, $6,060,344 was transferred from advanced on equipment purchases to construction in progress after the equipment was received.
 
 For the six months ended June 30, 2010, equipment in the amount of $322,027 was transferred as a reduction to accounts payable for $171,279 and as a reduction to other payables in the amount of $150,748.
 
 For the six months ended June 30, 2011, $10,783,230 of notes payable – short term were transferred to accounts payable vendors for the purchase of raw materials.  For the six months ended June 30, 2011, $4,408,950 of notes payable – short term was offset against notes receivable.
 18
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Note 6 – Accounts receivable, net
 
 Accounts receivable consisted of the following:
 
 June 30,


December 31,2011


2010(Unaudited)Accounts receivable

$
109,602,042


$
93,392,999Less: allowance for bad debts


(9,443,358
)


(7,493,667
)Accounts receivable, net

$
100,158,684


$
85,899,332
 
 The following table consists of allowance for bad debts:
 Allowance for bad debts at January 1, 2010

$
114,475Increase in allowance


-Negative provisions for allowance


(29,116)Accounts receivable write off


-Effect of foreign currency translation


3,447Allowance for bad debts at June 30, 2010 (Unaudited)


88,806Increase in allowance


7,686,302Negative provisions for allowance


(204,544)Accounts receivable write off


-Effect of foreign currency translation


(76,897
)Allowance for bad debts at December 31, 2010

$
7,493,667Increase in allowance


1,961,100Negative provisions for allowance


(45,118)Accounts receivable write off


(2,702)Effect of foreign currency translation


36,411Allowance for bad debts at June 30, 2011 (Unaudited)

$
9,443,358
 
 For the Simo Motor acquisition, the Company recorded acquired accounts receivables at the acquisition-date fair value. However, the fair value was disclosed on the Company’s Form 10K filing of 2009 with the original book value, reduced by a separate valuation allowance. Based on accounting guidance related to Business Combination, Paragraphs 805-20-30-1, a separate valuation allowances is not recognized for assets that are recorded at fair value at the acquisition date. Topic 805 requires assets, which include receivables and loans, to be measured at their acquisition-date fair value without a separate valuation allowance. As a result, the Company made a reclassification as follows as of December 31, 2009. No financial statement captions were impacted as only net numbers were stated on the balance sheet.
 
 December 31, 2009


Reclassification


December 31, 2009(Revised)Accounts receivable

$
97,302,153


$
(3,864,793
)

$
93,437,360Less: allowance for bad debts


(3,979,268
)


3,864,793



(114,475
)Accounts receivable, net

$
93,322,885


$
-


$
93,322,885
 
 19
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Note 7 – Inventories, net
 
 The following is a summary of inventories by major category:
 
 June 30,


December 31,2011


2010(Unaudited)Raw and packing materials

$
8,818,592


$
8,673,719Work in process


22,239,299



20,819,664Finished goods


33,735,144



29,252,978Finished goods - consignment


76,097



6,421,301Inventory valuation allowance


(3,073,528
)


(2,324,106
)Total inventories, net

$
61,795,604


$
62,843,556
 
 Allowance for inventory valuation at January 1, 2010

$
710,611Additional reserves


-Recovery of reserves


-Effect of foreign currency translation


-Allowance for inventory valuation at June 30, 2010 (Unaudited)


710,611Additional reserves


3,940,870Recovery of reserves


(2,340,118
)Effect of foreign currency translation


12,743Allowance for inventory valuation at December 31, 2010

$
2,324,106Additional reserves


878,988Recovery of reserves


(183,711
)Effect of foreign currency translation


54,145Allowance for inventory valuation at June 30, 2011 (Unaudited)

$
3,073,528
 
 For the Simo Motor acquisition, the Company recorded acquired inventory at the acquisition-date fair value. However, the fair value was disclosed on the Company’s Form 10K filing of 2009 with the original book value, reduced by a separate valuation allowance. Based on accounting guidance related to Business Combination, Paragraphs 805-20-30-1, a separate valuation allowances are not recognized for assets that are recorded at fair value at the acquisition date. Topic 805 requires assets, which include receivables and loans, to be measured at their acquisition-date fair value without a separate valuation allowance. As a result, the Company made a reclassification as follows as of December 31, 2009. No financial statement captions were impacted as only net numbers were stated on the balance sheet.
 
 December 31, 2009


Reclassification


December 31, 2009(Revised)Raw and packing materials

$
11,826,804


$
(2,903,706
)

$
8,923,098Work in process


28,434,522



(3,258,327
)


25,176,195Finished goods


25,471,544



(2,024,219
)


23,447,325Finished goods - consignment


18,077,870



-



18,077,870Inventory valuation allowance


(8,896,863
)


8,186,252


$
(710,611
)Total inventory, net

$
74,913,877


$
-


$
74,913,877
  20
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Note 8 – Advances on inventory purchases
 
 The Company makes advances to certain vendors for inventory purchases.  The advances on inventory purchases were $20,986,377 and $15,893,866 as of June 30, 2011 and December 31, 2010, respectively. For the three months ended June 30, 2011 and 2010, advances on inventory purchases amounted to $2,478,661 and $0, respectively, were directly written off due to vendors business failures. For the six months ended June 30, 2011 and 2010, $2,478,661 and $0 were directly written off from advances on inventory purchases.
 
 Note 9 – Plant and equipment, net
 
 The following table presents details of our property and equipment:
 
 June 30,


December 31,2011


2010(Unaudited)Buildings

$
93,638,488


$
90,434,596Office equipment


3,421,862



3,380,045Production equipment


61,437,436



45,564,179Vehicles


2,423,088



2,335,906Assets held for sale


46,263



46,071Construction in progress


57,651,085



43,172,049Total


218,618,222



184,932,846Less: accumulated depreciation


(16,739,593
)


(11,858,708
)Property and equipment, net

$
201,878,629


$
173,074,138
 
 Construction in progress represents labor costs, material, capitalized interest incurred in connection with the construction of the new plant facility in Shanghai and the construction and installation of manufacturing equipment in HTFE, Weihai, and Simo Motor.  Construction in progress as of June 30, 2011, consisted of the following:
 
 No.

Project Description

June 30,

2011

Commencement

Date

Expected

completion

date(Unaudited)1

Building construction for STFE facility

$
6,645,071

5/13/2009

12/31/20112

Manufacturing machinery and equipment for STFE


35,544,893

12/12/2008

9/30/20113

Building construction and manufacturing machinery and equipment for Weihai facility


15,267,358

8/20/2010

12/31/20114

Building construction and manufacturing machinery and equipment for Simo facility


169,651

11/30/2010 &

12/29/2010

12/31/20115

Others


24,112

Various

VariousTotal

$
57,651,085
 
 21
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Depreciation expense for the three months ended June 30, 2011 and 2010, amounted to $2,673,138 and $1,941,073, respectively. Depreciation expense for the six months ended June 30, 2011 and 2010, amounted to $5,061,037 and $3,829,181, respectively.
 
 For the six months ended June 30, 2011 and 2010, a total of $0 and $127,751 of interest were capitalized into construction in progress, respectively.
 
 Note 10 – Advances on non-current assets
 
 Advance for intangible assets
 
 The advances for intangible assets consisted of land use right prepayment. As of June 30, 2011 and December 31, 2010, advances for intangible assets amounted to $27,198,715 and $3,645,361, respectively.
 
 On September 8, 2006, HTFE entered into an agreement ("HTFE Land Use Agreement") with Shanghai Lingang Investment and Development Company Limited ("Shanghai Lingang") with respect to HTFE’s use of 40,800 square meters (approximately 10.1 acres) of State-owned land in the Shanghai Zhuqiao Airport Industrial Zone (the "Site").  The size of the land used by HTFE was later revised to a total of approximately 53,000 square meters (approximately 13.1 acres). The term of the HTFE Land Use Agreement is 50 years and the aggregate amount HTFE shall pay to Shanghai Lingang is approximately $6.28 million (RMB 42,840,000) ("Fee"), approximately 96.8% or $6.08 million (RMB 41,452,020) has been paid, as of June 30, 2011. HTFE shall register a Sino-foreign joint venture company at the location of Shanghai Lingang, with taxes payable at the same location. HTFE has agreed to compensate Shanghai Lingang for certain local taxes due to the local tax authority in connection with applicable tax generation requirements.
 
 On June 10, 2011, Simo Motor entered into a land use agreement (the “Simo Land Use Agreement”) with Xi’an Lintong Tourism and Business Development Management Commission (“Xi’an Lintong”) with respect to Simo Motor’s use of 500 Chinese Mu of land (approximately 82.4 acres or 333,500 square meters) located at Daixin Industrial Development Zone in Xi’an Lintong (the “New Site”). Pursuant to the Simo Land Use Agreement, the New Site will be used for construction of a new manufacturing facility that will produce electric equipment and machinery and related products as part of a capacity expansion project at Xi’an Simo. The term of the Simo Land Use Agreement is 50 years and the aggregate amount that Simo Motor shall pay to Xi’an Lintong is approximately $38.8 million (RMB 250 million). The Company made a pre-payment of $23.0 million (RMB 150 million) as of June 30, 2011 and will pay in full upon receipt of the land use license to be issued by the government.
 
 Advance on plant and equipment purchases
 
 The Company makes advances to certain vendors for equipments and construction projects.  The advances on equipment and construction amounted to $36,624,941 and $48,830,831 as of June 30, 2011 and December 31, 2010, respectively.
 
 Note 11 – Goodwill and other intangible assets
 
 Net intangible assets consist of the following at:
 
 June 30,

2011


December 31,

2010(Unaudited)Goodwill on 2008 Acquisition of Weihai

$
12,943,105


$
12,692,107Goodwill on 2009 Acquisition of Simo Motor


43,062,719



42,227,631Total goodwill


56,005,824



54,919,738Land use rights


18,147,584



17,794,376Patents


7,087,356



6,940,543Software


16,871



16,648Intellectual property


2,594,118



2,594,118Customer lists


288,235



288,235Total goodwill and other intangible assets


84,139,988



82,553,658Less: accumulated amortization


(5,478,169
)


(4,486,841
)Intangible assets, net

$
78,661,819


$
78,066,817
 
 22
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Amortization expense for the three months ended June 30, 2011 and 2010 amounted to $440,676 and $387,916, respectively. Amortization expense for the six months ended June 30, 2011 and 2010 amounted to $897,937 and $753,764, respectively.
 The Company uses the purchase method of accounting for business combinations. Annual testing for impairment of goodwill is performed during the fourth quarter of each year unless events or circumstances indicate earlier impairment testing is required. No impairment loss was recognized for the three months and six months ended June 30, 2011 and 2010. As a result of the disposition of three subsidiaries, effective April 1, 2010, Simo Motor no longer owns any of the outstanding equity of Tianjin Simo, Science and Technology, and Imports and Exports (see Note 3 for more discussion). Goodwill of these three former subsidiaries in the amount of $964,159 was included in the carrying amount of the reporting unit in determining the gain or loss on disposal.
 
 Weihai


Simo Motor


TotalGoodwill, as of January 1, 2010

$
12,273,778


$
41,799,976


$
54,073,754Disposal of subsidiaries


-



(964,159
)


(964,159
)Effect of foreign currency translation


-



-



-Goodwill, as of June 30, 2010 (unaudited)


12,273,778



40,835,817



53,109,595Disposal of subsidiaries


-



-



-Effect of foreign currency, translation


418,329



1,391,814



1,810,143Goodwill, as of December 31, 2010


12,692,107



42,227,631



54,919,738Effect of foreign currency translation


250,998



835,088



1,086,086Goodwill, as of June 30, 2011 (unaudited)

$
12,943,105


$
43,062,719


$
56,005,824
 
 Note 12 – Other assets
 
 Other assets, current, consisted of the following:
 
 June 30,

2011


December 31,2010(Unaudited)Other receivable, net

$
1,956,311


$
1,620,638Prepaid expenses


1,044,745



503,330Prepaid consulting service fee, current


600,000



-Deferred tax assets


314,935



377,727Total

$
3,915,991


$
2,501,695
 
 23
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Other assets, non-current, consisted of the following:
 
 June 30,

2011


December 31,2010(Unaudited)Security deposit

$
1,500


$
1,500Long term deferred expenses


340,176



677,491Prepaid consulting service fee, non-current


3,397,279



724,335Total

$
3,738,955


$
1,403,326
 
 Prepaid consulting service fee, non-current represent retainer fee or prepaid consulting fees to third parties. In February 2011, the Company entered into a consulting service agreement with a third party which agreed to provide advisory and consulting services to obtain financing in Chinese Capital Market for a period of 5 years from 2011 to 2015. The service fee is non-refundable and amounted to $3 million. For the three month and six month ended June 30, 2011, $139,052 and $200,000 was amortized as professional fees. As of June 30, 2011, prepayment of $600,000 and $2,200,000 were included in current and non-current prepaid consulting service fee, respectively.
 
 Note 13 – Taxes payable
 
 Taxes payable consisted of the following:
 June 30,

2011


December 31,

2010(Unaudited)VAT tax payable

$
1,645,155


$
1,930,544Individual income tax withholding payable


98,733



84,965Corporation income tax payable


5,902,207



3,672,511Other miscellaneous tax payable


3,074,492



2,517,787Total

$
10,720,587


$
8,205,807
 
 Note 14 – Financing
 
 On November 22, 2010, the Company entered into a Term Loan Facility Agreement, dated November 22, 2010 (the “CDB Agreement”) with China Development Bank Corporation, Hong Kong Branch (“CDB”) pursuant to which CDB has agreed to provide a USD$35,000,000 loan facility (“Facility A”) and an RMB100,000,000 loan facility (“Facility B,” and collectively with Facility A, the “Facilities”) to the Company (the loans made under Facility A shall be referred to herein as “Facility A Loans” and the loans made under Facility B shall be referred to herein as “Facility B Loans”). The Facility A Loans and the Facility B Loans shall be made pursuant to one or more borrowings from time to time during the period of time from the date of the CDB Agreement to the date falling on the expiration of six (6) months after the date of the CDB Agreement upon delivering a utilization request from the Company to CDB. Interest on Facility A Loans shall be 3% per annum plus LIBOR (as defined in the CDB Agreement). Interest on Facility B Loans shall be 2.5% per annum plus SHIBOR (as defined in the CDB Agreement). The Company is required to repay the Facility A Loans in two (2) equal installments on (i) the date which falls twenty four (24) months after the first utilization date of any loan and (ii) the date which falls thirty six (36) months after the first utilization date of any loan. The Company is required to repay the Facility B Loans in two (2) equal installments on (i) the date which falls twenty four (24) months after the first utilization date of any loan and (ii) the date which falls thirty six (36) months after the first utilization date of any loan.
 
 The CDB Agreement provides that the Company may, upon not less than one month’s prior notice prepay on an Interest Payment Date (as defined in the CDB Agreement) or a Repayment Date (as defined in the CDB Agreement) all or part of any loan (but if in part, in an amount that is an integral multiple of UDS$500,000 in the case of a Facility A Loan or RMB 2,000,000 in the case of Facility B Loan). The CDB Agreement also provides that upon a Change of Control (as defined in the CDB Agreement) of the Company, CDB may, by not less than 30 days notice to the Company, cancel the Facilities and declare all outstanding loans, together with accrued interest and all other amounts to be immediately due and payable.
  24
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 The Company’s obligations under the CDB Agreement are secured by a pledge of shares of common stock of the Company owned by its Chairman and Chief Executive Officer, Tianfu Yang. On November 22, 2010, Mr. Yang entered into a Security and Pledge Agreement (the “Pledge Agreement”) with CDB, pursuant to which, Mr. Yang has agreed to pledge 7,000,000 shares of common stock to CDB to secure the loans. Under the Pledge Agreement, Mr. Yang may also be obliged to pledge to CDB, under certain circumstances, additional shares of common stock owned by him and, to the extent such additional shares are not sufficient, cash.
 
 Debt issuance costs of $500,000, resulting from the Term Loan Facility Agreement the Company entered into with CDB, are carried in other assets and are amortized over the life of the loan using the straight-line amortization method. A total of $41,667 was amortized to interest expense for the three months ended June 30, 2011. A total of $83,334 was amortized to interest expense for the six months ended June 30, 2011. As of June 30, 2011, unamortized debt issuance costs totaled $413,470.
 
 Note 15 -Short and long term loans
 
 The Company’s short term loans are comprised of the following:
 
 June 30, 2011


December 31, 2010(Unaudited)Short term loans – bank

$
36,911,420


$
29,369,120Short term loans – others


24,752



121,360Total short term loans

$
36,936,172


$
29,490,480
  25
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 Short term loans – bank
 
 June 30, 2011


December 31,

2010(Unaudited)Loan from Citic Bank in city of Wendeng, due from various dates fromMay to June 2011. Monthly interest-only payments at 5.310% per annum,secured by assets

$
-

$
3,185,700Commercial bank in Weihai, due June June 3, 2012 monthly interest rate at 7.57% per annum, secured by assets and land use right


3,248,700


-Loan from Commercial Bank in city of Weihai, due from various dates from August to September 2011. Monthly interest-only payments at 0.509% per annum, secured by assets


1,237,600


1,213,600Loan from Bank of Communications, due in December 2011 to June 2012. Benchmark interest rate up by 10%, approximate rate of 6.116% to 6.94% per annum, guaranteed loan


3,094,000


3,034,000Loan from Citic Bank, due in December 2011 through February 2012. Average interest from 5.31% to 8.48% per annum, secured by assets and guaranteed loan


7,735,000


6,523,100Loan from China Merchant Bank, due various dates in June through   June 2012. Monthly interest-only payments from 6.37% to 6.97% per   annum, secured by assets and guaranteed by third party


3,403,400


8,495,200Loan from Bank of China. Monthly interest-only payment at 4% per annum, unsecured, and due upon demand.


866,320


849,520Loan from Bank of China, due in March through April 2012,  Benchmark interest rate up, approximately 6.19% per annum, secured by assets guaranteed loan.


11,602,500


-Loan from China Commercial Bank, due in November 2011. Monthly interest-only payment at 6.0% per annum, guaranteed loan


1,547,000


1,517,000Loan from Shanghai Pudong Development Bank in city of Xi’an, due    October 2011.  Interest-only payments at 6.1% per annum, secured  by Notes.


4,176,900Loan from Huaxia Bank in city of Xi’an, due various dates from February to March 2011.  Interest-only payments at 6.12% per annum, secured by assets.


-


4,551,000Short term loans – bank

$
36,911,420

$
29,369,120
 
 Long term loans – bank
 
 June 30,

2011


December 31,

2010(Unaudited)Loan from China Development Bank (see Note 14 for detail discussion of theTerm Loan Facility terms)

$
50,470,000


$
50,070,000$
50,470,000


$
50,070,000
 
 The above loans are secured by the Company's plants, buildings, land use rights and inventories located within PRC, with carrying net value as follows:
 
 June 30,

2011


December 31,

2010(Unaudited)Buildings in Xi’an, China

$
22,512,685


$
22,373,129Buildings in Weihai, China


2,209,720



2,166,868Land use rights in Xi’an and Weihai, China


12,417,590



1,122,435Inventories in Xi’an, China


9,422,528



9,102,000Total assets pledged as collateral for bank loans

$
46,562,523


$
34,764,432
 
 26
 
 HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Net interest expense for the three months ended June 30 was comprised of the following:
 
 2011


2010(Unaudited)


(Unaudited)Amortization of debt discount

$
-


$
312,741Amortization of debt issuance costs


41,667



140,968Interest expense


1,332,549



697,207Interest earned on cash deposits


(387,788
)


(208,854
)Foreign currency transaction loss


272,808



35,796Interest expense, net

$
1,259,236


$
977,858
 
 Net interest expense for the six months ended June 30 was comprised of the following:
 
 2011


2010(Unaudited)


(Unaudited)Amortization of debt discount

$
-


$
1,223,276Amortization of debt issuance costs


83,334



281,936Interest expense


3,242,682



1,492,424Interest earned on cash deposits


(608,371
)


(411,333
)Foreign currency transaction loss


465,541



38,478Interest expense, net

$
3,183,186


$
2,624,781
 
 Note 16 – Due to original shareholders
 
 Due to original shareholders represent the amount that was unpaid for the acquisition of Weihai, which consisted of the following:
 June 30,

2011


December 31,

2010(Unaudited)Amount due to Weihai original shareholders

$
773,500


$
758,500$
773,500


$
758,500
 
 Amount due to Weihai original shareholders is due on demand.
 
 Note 17 – Additional product sales information
 
 The Company has a single operating segment. The majority of the Company’s revenue was generated from domestic PRC sales.
 
 Summarized financial information concerning the Company’s revenues based on geographic areas for the three months ended June 30, 2011 and 2010, are as follows:
 
 2011

(Unaudited)


2010

(Unaudited)China

$
129,894,217


$
99,835,366International


1,507,570



5,600,604Total sales


131,401,787



105,435,970Cost of sales – China


94,189,993



66,759,306Cost of sales – International


1,007,685



3,344,477Total cost of sales


95,197,678



70,103,783Gross profit

$
36,204,109


$
35,332,187
  27
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Summarized financial information concerning the Company’s revenues based on geographic areas for the six months ended June 30, 2011 and 2010, are as follows:
 
 2011

(Unaudited)


2010

(Unaudited)China

$
229,992,059


$
198,257,076International


5,239,152



12,664,051Total sales


235,231,211



210,921,127Cost of sales – China


165,225,418



132,039,495Cost of sales – International


3,597,896



7,807,375Total cost of sales


168,823,314



139,846,870Gross profit

$
66,407,897


$
71,074,257
 
 The following tables present the revenue and cost of sales by each major product line for the three months ended June 30, 2011 and 2010:
 
 Revenues2011


2010Product Line

(Unaudited)


(Unaudited)Linear Motors and Related Systems

$
24,661,756


$
20,171,154Specialty Micro-Motors


18,209,848



15,119,614Rotary MotorsWeihai


29,200,895



23,563,810Xi’an


58,016,411



44,549,825Others


1,312,877



2,031,567Total

$
131,401,787


$
105,435,970
 
 Cost of Sales2011


2010Product Line

(Unaudited)


(Unaudited)Linear Motors and Related Systems

$
14,486,568


$
7,885,150Specialty Micro-Motors


12,036,028



9,508,102Rotary MotorsWeihai


25,878,817



20,684,380Xi’an


41,948,074



30,777,017Others


848,191



1,249,134Total

$
95,197,678


$
70,103,783
 
 28
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 The following tables present the revenue and cost of sales by each major product line for the six months ended June 30, 2011 and 2010:
 Revenues2011


2010Product Line

(Unaudited)


(Unaudited)Linear Motors and Related Systems

$
43,923,239


$
40,002,364Specialty Micro-Motors


33,742,179



31,364,328Rotary MotorsWeihai


50,970,594



46,032,148Xi’an


104,321,088



89,591,987Others


2,274,111



3,930,300Total

$
235,231,211


$
210,921,127
 
 Cost of Sales2011


2010Product Line

(Unaudited)


(Unaudited)Linear Motors and Related Systems

$
24,964,523


$
15,855,538Specialty Micro-Motors


22,585,538



19,542,335Rotary MotorsWeihai


45,111,246



40,289,239Xi’an


74,763,684



61,796,067Others


1,398,323



2,363,691Total

$
168,823,314


$
139,846,870
 
 Note 18 – Commitments and contingencies
 
 Commitments
 
 The Company enters into non-cancellable purchase commitments with some of its vendors. As of June 30, 2011 and December 31, 2010, the Company was obligated under the non-cancellable commitments to purchase materials totaling to $ 6,977,242 and $12,000,496, respectively. These commitments are short-term and expire within one year. The Company has not experienced losses on these purchase commitments over the years.
 
 On August 25, 2010, the Company entered into an agreement with Shelton Technology, LLC.  Under the terms of the agreement, the Company is required to contribute a total of $1 million to AAG prior to December 31, 2011.
 
 On September 8, 2006, HTFE entered into an agreement (“Land Use Agreement”) with Shanghai Lingang Investment and Development Company Limited (“Shanghai Lingang”) with respect to HTFE’s lease and use of 40,800 square meters (approximately 10.1 acres) of State-owned land in the Shanghai Zhuqiao Airport Industrial Zone (the “Site”). The size of the land used by HTFE was later revised to a total of approximately 53,000 square meters (approximately 13.1 acres). The term of the Land Use Agreement is 50 years and totaled $6.28 million (RMB 42.84 million) (“Fee”), approximately 96.8% or $6.08 million (RMB 41,556, 000) of which has been paid with the balance to be paid in installments.
 
 In March 2011, STFE increased the registered capital by $5.92 million from approximately $10 million to $15.9 million, 33% of the increase in registered capital has been injected into STFE on April 7, 2011. The remaining 67% of the increase in registered capital, which amounted to $3.9 million, is required to be injected into STFE on or before April 7, 2013.
 
 On June 10, 2011, Simo Motor entered into a land use agreement (the “Simo Land Use Agreement”) with Xi’an Lintong Tourism and Business Development Management Commission (“Xi’an Lintong”) with respect to Simo Motor’s use of 500 Chinese Mu of land located (approximately 82.4 acres or 333,500 square meters) at Daixin Industrial Development Zone in Xi’an Lintong (the “New Site”). Pursuant to the Simo Land Use Agreement, the New Site will be used for constructing a new manufacturing facility that produces electric equipment and machinery related products as part of a capacity expansion project at Xi’an Simo. The term of the Simo Land Use Agreement is 50 years and the aggregate amount that Simo Motor shall pay to Xi’an Lintong is approximately $38.8 million (RMB 250 million). The Company made a pre-payment of $23.0 million (RMB 150 million) as of June 30, 2011 and will pay in full upon receipt of the land use license to be issued by the government.
  29
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Contingencies
 
 Eleven shareholder class action lawsuits were filed against the Company and/or certain officers and the members of its Board of Directors (the “Board”), in connection with the October 10, 2010 non-binding proposal made by the Company’s Chairman and Chief Executive Officer, Mr. Tianfu Yang, and Baring Private Equity Asia Group Limited to acquire all of the outstanding shares of the Company’s Common Stock not currently owned by Mr. Yang and his affiliates for $24.00 per share in cash, as further described in the Schedule 13D/A and Exhibits thereto filed on October 12, 2010 (the “Proposal”). Six actions were filed in Nevada state court (Carson City, Clark County, or Washoe County); two actions were filed in Nevada federal district court, and three actions were filed in New York state court. All of the actions assert claims against the Company and/or members of the Board for allegedly breaching their fiduciary duties in connection with the Proposal.
 
 Guarantee of Third-Party Indebtedness—No Liability Is Recorded
 
 As China only began its economic reform and development of a market economy in the 1980s, its credit evaluation system has had only a very short history and is far less sophisticated than in the developed countries. Therefore, when an enterprise applies for a loan from a commercial bank, it is difficult for the bank to evaluate the credit risk of the applicant. As an alternative tool, it is a common practice in China for commercial banks to require the applicant to find an unrelated third-party in its local economy to provide a loan guarantee for the applicant, which serves as a credit enhancement for the bank. In return, such guarantors often require the counterparty to provide similar guarantees on their own debt. Therefore, this type of guarantee is usually a cross-guarantee.
 
 As of March 31, 2011, the Company was contingently liable as guarantor with respect to $3,050,000 of indebtedness of Baoji Zhongcheng Machinery Co. Ltd. (“Baoji”). The term of the guarantee was through April 2011 and was not extended. Baoji was also contingently liable as guarantor for the Company with respect to $4,575,000 of indebtedness. That guarantee agreement ended in June 2011.  There was no cross-guarantee agreements in effect as of June 30, 2011.
 
 Note 19 – Earnings per share
 
 FASB requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share.  Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. The following is a reconciliation of the basic and diluted earnings per share computations:
  30
 
 HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 For the three months ended June 30:
 
 2011


2010(Unaudited)


(Unaudited)Net income before noncontrolling interest

$
17,167,804


$
25,675,574Less: Net income attributable to noncontrolling interest


5,866



770Net income attributable to controlling interest

$
17,161,938


$
25,674,804Weighted average shares used in basic computation


31,250,820



31,067,471Diluted effect of stock options and warrants


100,319



275,835Weighted average shares used in diluted computation


31,351,139



31,343,306Earnings per share - Basic:Net income before noncontrolling interest

$
0.55


$
0.83Less: Net income attributable to noncontrolling interest

$
-


$
-Net income attributable to controlling interest

$
0.55


$
0.83Earnings per share - Diluted:Net income before noncontrolling interest

$
0.55


$
0.82Less: Net income attributable to noncontrolling interest

$
-


$
-Net income attributable to controlling interest

$
0.55


$
0.82
 
 For the six months ended June 30:
 
 2011


2010(Unaudited)


(Unaudited)Net income before noncontrolling interest

$
27,987,745


$
48,581,615Less: Net income attributable to noncontrolling interest


20,135



2,353,123Net income attributable to controlling interest

$
27,967,610


$
46,228,492Weighted average shares used in basic computation


31,250,820



31,067,471Diluted effect of stock options and warrants


86,510



281,092Weighted average shares used in diluted computation


31,337,330



31,348,563Earnings per share - Basic:Net income before noncontrolling interest

$
0.90


$
1.56Less: Net income attributable to noncontrolling interest

$
-


$
(0.08
)Net income attributable to controlling interest

$
0.89


$
1.49Earnings per share - Diluted:Net income before noncontrolling interest

$
0.89


$
1.55Less: Net income attributable to noncontrolling interest

$
-


$
(0.08
)Net income attributable to controlling interest

$
0.89


$
1.47
 
 Except for 30,000 stock options at $20.02 per share, all stock options and warrants have been included in the diluted earnings per share calculation for the three months and six months ended June 30, 2011.  All stock options and warrants have been included in the diluted earnings per share calculation for the three months and six months ended June 30, 2010.
 
 Note 20 – Shareholders’ equity
 
 Statutory reserves
 
 The laws and regulations of the People’s Republic of China require that before a Sino-foreign cooperative joint venture enterprise distributes profits to its partners, it must first satisfy all tax liabilities, provide for losses in previous years, and make allocations in proportions determined at the discretion of the board of directors, after the statutory reserve.
  31
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Surplus reserve fund
 
 The Company is required to transfer 10%-15% of its net income, as determined in accordance with the PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital. The transfer to this reserve must be made before distribution of any dividend to shareholders. The Company will transfer at year end 10%-15% of the year’s net income determined in accordance with PRC accounting rules and regulations.
 
 For the six months ended June 30, 2011 and 2010, the Company transferred $3,736,713 and $5,044,288, respectively, representing 10% -15% of the net income generated by the Company’s subsidiaries located within PRC determined in accordance with PRC accounting rules and regulations, to this reserve. The remaining reserve to fulfill the 50% registered capital requirement amounted to approximately $37.9 million and $38.7 million as of June 30, 2011 and December 31, 2010, respectively.
 
 The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital.
 
 Warrants
 
 Following is a summary of warrant activity:
 
 Outstanding as of January 1, 2010


366,697Granted


-Forfeited


-Exercised


-Outstanding as of June 30, 2010 (Unaudited)


366,697Granted


-Forfeited


-Exercised


(183,349
)Outstanding as of December 31, 2010


183,348Granted


-Forfeited


-Exercised


-Outstanding as of June 30, 2011 (Unaudited)


183,348
 
 Following is a summary of the status of warrants outstanding at June 30, 2011:
 
 Outstanding Warrants


Exercisable WarrantsExercise Price

Number of

Shares


Average

Remaining

Contractual

Life


Average

Exercise Price


Number of

Shares


Average

Remaining

Contractual

Life$
10.84


183,348



1.17


$
10.84



183,348



1.17Total


183,348











183,348
 
 32
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Options
 
 On November 30, 2009, the Company granted options to an independent director to purchase an aggregate of 30,000 shares of the Company's common stock, at an exercise price of $20.02 per share, the closing price of the Company’ s common stock on November 30, 2009. The fair values of stock options granted to employees and the independent directors were estimated at the date of grant using the BSM with the following assumptions:
 
 Expected

Expected


Dividend


Risk Free


Grant DateLife

Volatility


Yield


Interest Rate


Fair ValueExecutives - 2007

3.0 yrs


77
%


0
%


4.50
%

$
15.60Directors - 2009

3.0 yrs


70
%


0
%


1.15
%

$
20.02
 
 Following is a summary of stock option activity:
 
 Options Outstanding


Weighted

Average

Exercise Price


Aggregate Intrinsic

ValueOutstanding as of December 31, 2009


355,000


$
13.97


$
2,333,600Granted


-



-



-Forfeited


-



-



-Exercised


-



-



-Outstanding as of June 30, 2010 (Unaudited)


355,000


$
13.97


$
951,400Granted


-



-



-Forfeited


-



-



-Exercised


-



-



-Outstanding as of December 31, 2010


355,000


$
13.97


$
1,199,900Granted


-



-



-Forfeited


(95,000
)


8.10



1,043,100Exercised


-



-



-Outstanding as of June 30, 2011 (Unaudited)


260,000


$
16.11


$
-
 
 Following is a summary of the status of options outstanding at March 31, 2011:
 
 Outstanding Options


Exercisable OptionsExercise Price

Number


Average Remaining

Contractual Life


Average

Exercise Price


Number


Average Remaining

Contractual Life$
15.60


230,000



1.46


$
15.60



230,000



1.46$
20.02


30,000



3.42


$
20.02



22,500



3.42Total


260,000











252,500
 
 On July 12, 2007, the Company’s CEO transferred 280,000 of his own shares to the Company employees and consultants. The shares vest over 5 to 10 years starting July 12, 2007. The Company valued the shares at $13.73 per share, based on the average price for the immediately preceding fifteen consecutive trading days before June 16, 2007, the date when the Company and HTFE entered into the asset purchase agreement with Harbin Taifu Auto Electric Co., Ltd., the trading price of the stock on the date of transfer, as a capital contribution totaling $3,844,904 by the CEO, the value was amortized over the vesting period.
 
 For the three months ended June 30, 2011 and 2010, stock compensation expense related to options issued amounted to $111,297 and $254,669, respectively. For the six months ended June 30, 2011 and 2010, stock compensation expense related to options issued amounted to $222,594 and $509,338, respectively.
  33
  HARBIN ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2011
 (UNAUDITED)
 
 Note 21 – Employee pension
 
 Regulations in the People’s Republic of China require the Company to contribute to a defined contribution retirement plan for all employees. All Joint Venture employees are entitled to a retirement pension amount calculated based upon their salary at their date of retirement and their length of service in accordance with a government managed pension plan. The PRC government is responsible for the pension liability to the retired staff. The employee pension in Harbin generally includes two parts: the first part to be paid by the Company is 20% of the employees’ actual salary in the prior year. If the average salary falls below $1,165 for each individual, $1,165 will be used as the basis. The other part, paid by the employees, is 8% of actual salary with the same minimum requirement. The Company made contributions to employment benefits, including pension, of $1,038,023 and $350,786 for the three months ended June 30, 2011 and 2010, respectively. The Company made contributions to employment benefits, including pension, of $2,056,997 and $564,549 for the six months ended June 30, 2011 and 2010, respectively.
 
 Note 22 – Subsequent event
 
 In August 2011, 183,348 Warrants were exercised into 183,348 shares of the Company’s common stock.





34





Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations





INFORMATION REGARDING FORWARD LOOKING STATEMENTS





The following is management’s discussion and analysis of certain significant factors that have affected aspects of our financial position and results of operations during the periods included in the accompanying unaudited financial statements. You should read this in conjunction with the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited financial statements for the year ended December 31, 2010 included in our Annual Report on Form 10-K and the unaudited consolidated financial statements and notes thereto set forth in Item 1 of this Quarterly Report. In addition to historical information, this discussion and analysis contains forward-looking statements that relate to future events and expectations and, as such, constitute forward-looking statements. Forward-looking statements include those containing such words as “anticipates,” “believes,” “estimates,” “expects,” “hopes,” “targets,” “should,” “will,” “will likely result,” “forecast,” “outlook,” “projects” or similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance or achievements of the Company to be materially different from those expressed or implied in the forward-looking statements.





OVERVIEW





Harbin Electric, Inc. (“Harbin Electric” or the “Company”) is incorporated under the laws of the state of Nevada and, along with our wholly-owned subsidiaries, is headquartered in Harbin, China. We design, develop, manufacture, supply, and service a wide range of electric motors, with a focus on innovation, creativity, and value-added products. Our major product lines include linear motors, specialty micro-motors, and industrial rotary motors. Our products are purchased by a broad range of customers including those customers in the energy industry, factory automation, food processing, packaging industry, power generation systems, mass transportation and freight transportation systems, chemical, petrochemical, metallurgical, mining, textile, agricultural, and machinery industries. We primarily supply domestic markets in China and also certain international markets.





We currently operate the following four manufacturing facilities in China with an employee base of approximately 4,320 engineers, production technicians, and other employees:





·
Harbin Tech Full Electric Co., Ltd. (“Harbin Tech Full”) is located in the government-designated Development Zone in the city of Harbin with approximately 50,000 square meters of land and manufactures linear motors and linear motor integrated systems.





·
Shanghai Tech Full Electric Co., Ltd. (“Shanghai Tech Full”) is located in the Shanghai Zhuqiao Airport Industrial Zone with 40,800 square meters of land and manufactures specialty micro-motors.





·
Weihai Tech Full Simo Motor Co., Ltd. (“Weihai Tech Full Simo”) is located in Weihai with approximately 150,000 square meters of land and primarily manufactures small to medium sized industrial rotary motors.





·
Xi’an Tech Full Simo Motor Co., Ltd. (“Xi’an Tech Full Simo”) was acquired in October 2009 and manufactures primarily medium to large sized industrial rotary motors. Xi’an Tech Full Simo is located in Xi’an city’s Economy and Technology Development Zone and occupies approximately 200,000 square meters of land.





We are subject to risks common to companies operating in China, including risks inherent in our distribution and commercialization efforts, uncertainty of foreign regulatory and marketing approvals and laws, reliance on key customers, enforcement of patent and proprietary rights, the need for future capital, and retention of key employees. We cannot provide assurance that we will generate revenues or achieve and sustain profitability in the future.





RECENT EVENTS





On June 19, 2011, the Company entered into an Agreement and Plan of Merger, dated June 19, 2011 (“Merger Agreement”), with Tech Full Electric Company Limited, a Cayman Islands exempted company with limited liability, wholly owned indirectly by Mr. Tianfu Yang, the Company’s Chairman and Chief Executive Officer (“Parent”) and Tech Full Electric Acquisition, Inc., a Nevada corporation and a wholly-owned subsidiary of Parent (“Merger Sub”).





Pursuant to the Merger Agreement, upon the terms and subject to the conditions thereof, at the effective time of the merger, Merger Sub will be merged with and into the Company, the Company will become a wholly-owned subsidiary of the Parent and each of the Company’s shares of common stock issued and outstanding immediately prior to the effective time of the merger (the “Shares”) will be converted into the right to receive $24.00 in cash without interest, except for Shares owned by Parent and Merger Sub (including shares to be contributed to Parent by Mr. Tianfu Yang, affiliates of Abax Global Capital (“Abax”) and certain of the Company’s employees and officers (collectively, the “Purchasing Group”) prior to the effective time of the merger pursuant to a contribution agreement between Parent, each member of the Purchasing Group and Tianfu Investments Limited, a Cayman Islands company directly owning 100% of the equity interest in Parent). Currently, the Purchasing Group collectively beneficially owns approximately 40.39% of the Company’s outstanding shares of common stock.


35





The Merger Agreement contains customary representations and warranties of the Company, on the one hand, and of Parent and Merger Sub, on the other. The assertions embodied in those representations and warranties were made solely for purposes of the Merger Agreement and may be subject to important qualifications and limitations agreed to by the Company, Parent and Merger Sub in connection with the negotiated terms of the Merger Agreement.





The Merger Agreement also includes customary covenants of the Company, Parent and Merger Sub. Except as expressly provided in the Merger Agreement, the Company has agreed that until the effective time of the merger that it shall use its reasonable best efforts to conduct its business in the ordinary course of business, to preserve substantially intact its business organization and to preserve its present relationships with customers, suppliers and other persons with which it has material business relations. The Company has also agreed not to solicit or initiate discussions with third parties regarding other proposals to acquire the Company and to certain restrictions on its ability to respond to or accept any such proposal.





The Merger Agreement also includes customary termination provisions for both the Company and Parent. If the Merger Agreement is terminated under certain circumstances, the Company will be required to pay Parent a termination fee of $22,500,000. If the Merger Agreement is terminated under certain other circumstances, Parent will be required to pay the Company a termination fee equal to $30,000,000.





The Company’s Board of Directors, acting upon the unanimous recommendation of a special committee of the Board of Directors comprised solely of independent and disinterested directors (the “Special Committee”), approved and adopted the Merger Agreement and has recommended that the Company’s shareholders vote to approve the Merger Agreement. The Special Committee negotiated the terms of the Merger Agreement with the assistance of legal and  financial advisors to the Special Committee.





The merger is currently expected to close in the fourth quarter of this year, and is subject to customary closing conditions as well as approval and adoption of the Merger Agreement by the Company’s shareholders (including the affirmative approval of the holders of a majority in combined voting power of the outstanding Shares not owned by the Purchasing Group). Accordingly, no assurance can be given that the merger will be completed.





On July 13, 2011, the Company filed a Preliminary Proxy Statement (“Preliminary Merger Proxy”) together with a Schedule 13E-3 with the Securities Exchange Commission (“SEC”) indicating its intention to call a special meeting of its shareholders at a still to be specified date to vote on the Merger Agreement for the Company to go private.


If completed, the merger will result in the Company becoming a privately-held company, and the Shares will no longer be listed on any public market.





CRITICAL ACCOUNTING POLICIES AND ESTIMATES





We believe that the application of the following accounting policies, which are important to our financial position and results of operations, require significant judgments and estimates on the part of management. Our critical accounting policies and estimates present an analysis of the uncertainties involved in applying a principle, while the accounting policies note to the financial statements (Note 2) describe the method used to apply the accounting principle.





Accounts Receivable





Accounts receivable are presented net of an allowance for bad debts account. The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends, and changes in customer payment patterns to evaluate the adequacy of these reserves. The estimated loss rate is based on the Company’s historical loss experience and also considerations of current market conditions. Delinquent account balances are written-off after management has determined that the likelihood of collection is not probable, and known bad debts are written off against allowance for doubtful accounts when identified.





Inventories





Inventories are valued at the lower of cost or market value, as determined on a first-in, first-out basis, using the weighted average method. Management compares the cost of inventories with the market value and an allowance is made for writing down the inventories to its market value, if lower than cost. On an ongoing basis, inventories are reviewed for potential write-down for estimated obsolescence or unmarketable inventories equal to the difference between the costs of inventories and the estimated net realizable value based upon forecasts for future demand and market conditions. When inventories are written-down to the lower of cost or market, they are not marked up subsequently based on changes in underlying facts and circumstances.  Inventories are composed of raw material for manufacturing electrical motors, work in process and finished goods within the Company’s warehouse premise or consigned at a customer site. The inventory allowance is made when the inventory’s market value is lower than the cost. The recovery of the reserve is only made through sale or disposition of such inventory items.





36


Notes payable





In general, the short term notes are bank acceptance notes payable issued by local banks in China that entitle the Company’s suppliers to receive the full face amount from the issuing banks. In China, this is a very common low cost financial instrument used to pay suppliers.





Our bank acceptance notes payable represent short-term notes payable issued by Chinese banks in connection with the Company’s purchases that entitle the Company’s suppliers to receive the full face amount from the financial institutions at maturity, which range six to twelve months from the date of issuance. The notes payable were secured by the Company’s restricted cash deposited with issuing banks. All the bank acceptance notes are subject to bank charges of 0.05% of the principal as a commission on each loan transaction. The amount borrowed is entered in the accounting records by increasing cash or as payments to vendors, and increasing notes payable.  When the note is repaid, the difference between the carrying amount of the note and the cash necessary to repay that note is reported as interest expense.





Revenue Recognition





The Company recognizes sales when title and risk of ownership are passed to the customer (which is at the date of shipment), when a formal arrangement exists, the price is fixed or determinable, no other significant obligations exist and collectability is reasonably assured. For products that are required to be examined by customers, sales revenue is recognized after the customer examination period has passed. Payments received before all of the relevant criteria for revenue recognition are satisfied, are recorded as customer deposits.





In addition, revenue recognition could be negatively impacted by returns. For our linear motor and specialty micro-motor businesses, our products are custom products which are customer specific, and no returns are allowed. We warrant our product for repair, only in the event of defects for two years from the date of shipment.  We charge such costs to cost of goods sold. For our industrial rotary motor business, our products are standardized products and returns are allowed within three days upon receipt of products by customers. We provide product warranty for repair one year from the date of shipment. Historically, the returns and defects have not been material. Should returns increase in the future it would be necessary to adjust the estimates, in which case recognition of revenues could be delayed.





The Company also provides after-sale services to our customers. Service revenue is recognized as services are rendered, the customers have approved the completion of the services and invoices have been issued and collectability is reasonably assured. Customer billings for services not yet rendered are deferred and recognized as revenue as the services are rendered and the associated deferred revenue is included in current liabilities or long-term liabilities, as appropriate.





The Company recognizes revenues with regards to the sales of consigned inventories when the title and risks of ownership have been transferred to customers, customers provide persuasive evidence to notify the Company, and upon receipt of the notification from customers. The Company also performs periodic inventory counts to confirm the inventory quantities held on consignment.





Customers who purchase industrial rotary motors are divided into two major categories: distributors and non-distributors. Non-distributors consist of OEM users, traders and end users. Except for the annual sales target for distributors, the sales arrangements are the same with distributors and non-distributors.





Distributors are committed to annual purchase targets and may be entitled to a sales rebate. The Company periodically provides incentive offers to its distributors to encourage purchases. Such offers include inducement offers (e.g., offers of future discounts subject to meeting the customer’s annual purchase target), and other similar offers. Inducement offers, when accepted by customers, are treated as a reduction to purchase price based on estimated future redemption rates. Redemption rates are estimated using the Company’s historical experience for similar inducement offers. Inducement offers are presented as a net amount in “net sales.”





Stock-Based Compensation





We record share-based compensation expense based upon the grant date fair value of share-based awards. The value of the award is principally recognized as expense ratably over the requisite service periods. We use the Black-Scholes Merton (“BSM”) option-pricing model, which incorporates various assumptions including volatility, expected life and interest rates to determine fair value. The Company’s expected volatility assumption is based on the historical volatility of Company’s stock. The expected life assumption is primarily based on the simplified method of the terms of the options. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant.





The Company is required to measure the cost of the equity instruments issued in exchange for the receipt of goods or services from other than employees at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably determinable. The value of equity instruments issued for consideration other than employee services is determined on the earlier of a performance commitment or completion of performance by the provider of goods or services.





Stock compensation expense is recognized based on awards expected to vest.  GAAP requires forfeitures to be estimated at the time of grant and revised in subsequent periods, if necessary, when actual forfeitures differ from those estimates.  There were no estimated forfeitures as the Company has a short history of issuing options and the actual forfeitures during the history of issuing options were minimal.


37


Fair Value of Financial Instruments





On January 1, 2008, the Company began recording financial assets and liabilities subject to recurring fair value measurement at the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. On January 1, 2009, the Company began recording non-recurring financial as well as all non-financial assets and liabilities subject to fair value measurement under the same principles. These fair value principles prioritize valuation inputs across three broad levels. The three levels are defined as follows:





·
Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.


·
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.


·
Level 3 inputs to the valuation methodology are unobservable and significant to the fair value.





Recent Accounting Pronouncement





In April 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard UpdateNo. 2011-02,Receivables (Topic 310) – A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring, which clarify when a modification or restructuring of a receivable constitutes a troubled debt restructuring. In evaluating whether such a modification or restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that two conditions exist: (1) the modification or restructuring constitutes a concession and (2) the debtor is experiencing financial difficulties. The guidance will be effective for our interim and annual reporting periods beginning after June 15, 2011 and will be applied retrospectively to the beginning of the annual period of adoption. The adoption of this newly issued guidance is not expected to have a material impact on our consolidated financial statements.





In May 2011, FASB issued Fair Value Measurement (Topic 820) — Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs No. 2011-0, which provides additional guidance for fair value measurements. These updates to the ASC or Codification include clarifications regarding existing fair value measurement principles and disclosure requirements, and also specific new guidance for items such as measurement of instruments classified within stockholders’ equity and disclosures regarding the sensitivity of Level 3 measurements to changes in valuation model inputs. These updates to the Codification are effective for interim and annual periods beginning after December 15, 2011. The Company does not expect the implementation of this guidance to have a material impact on its consolidated financial statements.





In June 2011, the FASB issued Comprehensive Income (Topic 220) — Presentation of Comprehensive Income (ASU No. 2011-05), which updates the Codification to require the presentation of the components of net income, the components of other comprehensive income (OCI) and total comprehensive income in either a single continuous statement of comprehensive income or in two separate, but consecutive statements of net income and comprehensive income. These updates do not affect the items reported in OCI or the guidance for reclassifying such items to net income. These updates to the Codification are effective for interim and annual periods beginning after December 15, 2011. The Company does not expect the implementation of this guidance to have a material impact on its consolidated financial statements.





RESULTS OF OPERATIONS





THREE MONTHS ENDED JUNE 30, 2011 AND 2010





Revenues





In the second quarter of 2011, total revenues were $131.4 million, up $26.0 million or 24.6%, compared with $105.4 million in the second quarter of 2010. The significant sales growth was mainly the result of higher sales across all major product lines. In linear motors and related systems, sales were up $4.5 million year-over-year. A slightly lower sales volumes in oil pumps (145 units in the second quarter of 2011, compared with 150 units in the same period of 2010) and in propulsion systems for coal transportation trains were more than offset by higher volumes in other linear motors and sales of new products. In specialty micro motors, sales increased by $3.1 million driven by higher volumes of existing products and sales of new products. Rotary motor sales were up $13.5 million and $5.6 million at Xi’an Tech Full Simo and at Weihai Tech Full Simo, respectively, driven primarily by higher volumes and higher pricing.





The following table presents the revenue contribution by percentage for each major product line in the second quarter of 2011 in comparison with the second quarter of 2010.


Percent of Total RevenuesProduct Line

2Q11


2Q10Linear Motors and Related Systems


18.8
%


19.1
%Specialty Micro-Motors


13.9
%


14.4
%Rotary Motors


66.3
%


64.6
%Weihai


22.2
%


22.3
%Xi’an


44.1
%


42.3
%Others


1.0
%


1.9
%Total


100
%


100
%




38





Net Income





The Company recorded a net income attributable to controlling interest of $17.2 million, or $0.55 per diluted share in the second quarter of 2011, compared with a net income attributable to controlling interest of $25.7 million, or $0.82 per diluted share in the same period of 2010. The net income attributable to controlling interest was 33.1% lower than in the second quarter of 2010 primarily due to the following factors:





1.
Lower gross profit margin (see section titled “Gross Profit Margin” for the three months ended June 30, 2011 and 2010);





2.
Higher research & development expense and higher selling, general and administrative expenses (see section titled “Operating Expenses” for the three months ended June 30, 2011 and 2010); and





3.
Higher income tax rate (see section titled “Income Tax” for the three months ended June 30, 2011 and 2010).





The net profit margin (net income attributable to controlling interest as a percentage of total revenues) was 13.1% and 24.4% in the second quarter of 2011 and 2010, respectively.





Gross Profit Margin





The following table presents the average gross profit margin by product line for the three months ended June 30, 2011, compared with the same period in 2010.





Gross Profit MarginProduct Line

2Q11


2Q10Linear Motors and Related Systems


41.3
%


60.9
%Specialty Micro-Motors


33.9
%


37.1
%Rotary Motors


22.2
%


24.4
%Weihai


11.4
%


12.2
%Xi’an


27.7
%


30.9
%Others


35.4
%


38.5
%Corporate Average


27.6
%


33.5
%





The decline in overall gross margin was primarily due to higher raw material costs and labor costs across all product lines. An increase of $0.4 million in depreciation expense in the cost of sales also hurt the overall gross margin. Changes in product mix and selling price also contributed to changes in gross margin.  Although the Company anticipates passing on a portion of the higher costs of raw materials through increased selling prices, it is expected that higher raw material prices will continue to pressure gross margin.





In linear motors and related systems, margin compression was mainly attributable to the following factors in addition to higher raw material and labor costs:





1.
Changes in product mix. Sales volumes of higher margin products – oil pumps and propulsion systems for coal transportation trains – declined in the second quarter of 2011 compared with the same period a year ago, while sales volumes of lower margin products increased significantly.





2.
Lower unit selling prices for certain products. In order to expand our customer base and gain market share, we lowered selling prices for certain products.





In specialty micro motors, lower gross margin was primarily attributable to the following factors in addition to higher raw material and labor costs:





1.
Launch of new products, compared with the second quarter of last year. New product launches generally experience higher manufacturing costs during the start-up stage due to higher costs associated with workforce training, additional test runs, and smaller initial orders, which result in reduced production efficiency.





2.
Changes in product mix. Sales volumes of higher-margin products declined while sales volumes of lower-margin products increased.


39





In rotary motors, gross margin declined mainly due to higher raw material and labor costs partially offset by higher pricing.




Operating Expenses





Research and development (R&D) expenses increased to $0.9 million in the three months ended June 30, 2011 from $0.4 million in the three months ended June 30, 2010.





Selling, general and administrative expenses (SG&A) amounted to $13.8 million and $6.9 million in the second quarter of 2011 and 2010, respectively, or 10.5% and 6.5% of each quarter’s total revenues. The year-over-year increase in SG&A primarily reflected the following additional expenses compared to the second quarter of 2010:





1.
Expense related to advances on inventory purchases totaling $2.5 million that were written off due to vendors business failures.





2.
Expenses in the second quarter of 2011 related to the Going Private process (see section titled “Recent Events”) totaled $3.3 million. This amount included legal fees associated with the class action lawsuits (see Part II, Item 1 “Legal Proceedings”), fees associated with legal and financial advisors for the Special Committee of the Board of Directors, and other related expenses. The Company expects to recover some of the legal expenses related to the class action lawsuits pursuant to its insurance policy.





Operating profits were $21.5 million and $28.1 million in the second quarter of 2011 and 2010, respectively, with operating margin at 16.3% and 26.6%, respectively.





Other Income (net)





Other income was $2.4 million and $1.3 million in the second quarter of 2011 and 2010, respectively. Other income mainly included income from recycling scrap materials and selling production waste.





Interest Expense (net)





Net interest expense was $1.3 million and $1.0 million in the second quarter of 2011 and 2010, respectively. Net interest expense in the second quarter of 2011 mainly included $1.3 million interest expense, $0.4 million interest income, and $0.3 million of foreign currency transaction loss. Net interest expense in the second quarter of 2010 mainly included $0.5 million amortization of debt discount and debt issuance cost, $0.7 million interest expense, and $0.2 million interest income.





See Note 15 for a breakdown of interest expense.





Income Taxes





Provision for income tax was $6.0 million and $3.8 million in the second quarter of 2011 and 2010, respectively.





The corporate income tax rates in 2011 for some of our PRC subsidiaries are higher than in 2010 due to the expiration of the previous preferential tax rates approved by the government. Harbin Tech Full was subject to a 10% preferential tax rate in 2010 that expired at the end of 2010. Harbin Tech Full is in the process of applying for a new preferential income tax rate from the Chinese government. Management believes that it is highly likely that Harbin Tech Full will be approved for a 15% preferential income tax rate for 2011. However, since the approval process may take six months or longer, the management of Harbin Tech Full opted for caution and used a 25% standard income tax rate to calculate the provision for income tax for the first six months of 2011. The 25% income tax rate for Harbin Tech Full has caused the provision for income tax at Harbin Tech Full to be significantly higher in the second quarter of 2011 than in the second quarter of 2010. The 10% preferential tax rate as opposed to the 25% standard rate resulted in a $1.7 million savings on tax in the second quarter of 2010. Shanghai Tech Full was subject to an 11% preferential tax rate in 2010 and has been granted a 12% preferential tax rate in 2011. Xi’an Tech Full Simo remains at a 15% preferential tax rate in 2011. Weihai Tech Full has been subject to the standard 25% tax rate.





SIX MONTHS ENDED JUNE 30, 2011 AND 2010





Revenues





For the first six months of 2011, total revenues were $235.2 million, up $24.3 million or 11.5%, compared with $210.9 million in the same period of 2010. The significant sales growth was mainly the result of higher sales across all major product lines in the second quarter of 2011. In linear motors and related systems, sales were up $3.9 million year-over-year. Lower sales volumes in oil pumps (220 units in the first six months of 2011, compared with 255 units in the same period of 2010) and in propulsion systems for coal transportation trains were more than offset by higher volumes in other linear motors and sales of new products. In specialty micro motors, sales increased by $2.4 million driven primarily by higher volumes and sales of new products. Rotary motor sales were up $14.7 million and $4.9 million at Xi’an Tech Full Simo and at Weihai Tech Full Simo, respectively, attributable primarily to higher volumes and higher pricing.


40





The following table presents the revenue contribution by percentage for each major product line in the six months ended June 30, 2011 in comparison with the six months ended June 30, 2010.





Percent of Total RevenuesSix Months Ended June 30,Product Line

2011


2010Linear Motors and Related Systems


18.7
%


19.0
%Specialty Micro-Motors


14.3
%


14.9
%Rotary Motors


66.0
%


64.3
%Weihai


21.7
%


21.8
%Xi’an


44.3
%


42.5
%Others


1.0
%


1.8
%Total


100
%


100
%





Net Income





The Company recorded a net income attributable to controlling interest of $28.0 million, or $0.89 per diluted share in the first six months of 2011, compared with $46.2 million, or $1.47 per diluted share in the same period of 2010. The net income attributable to controlling interest was 39.5% lower than in the first six months of 2010 primarily due to the following factors:





1.
Lower gross profit margin (see section titled “Gross Profit Margin” for the six months ended June 30, 2011 and 2010);





2.
Higher research & development expenses and higher selling, general and administrative expenses (see section titled “Operating Expenses” for the six months ended June 30, 2011 and 2010); and





3.
Higher income tax rate (see section titled “Income Tax” for the six months ended June 30, 2011 and 2010).





The net profit margin (net income attributable to controlling interest as a percentage of total revenues) was 11.9% and 21.9% in the first six months of 2011 and 2010, respectively.





Gross Profit Margin





The following table presents the average gross profit margin by product line for the six months ended June 30, 2011, in comparison with the six months ended June 30, 2010.





Gross Profit MarginSix Months Ended June 30,Product Line

2011


2010Linear Motors and Related Systems


43.2
%


60.4
%Specialty Micro-Motors


33.1
%


37.7
%Rotary Motors


22.8
%


24.7
%Weihai


11.5
%


12.5
%Xi’an


28.3
%


31.0
%Others


38.5
%


39.9
%Total


28.2
%


33.7
%





The decline in overall gross margin was primarily due to higher raw material costs and labor costs across all product lines. An increase of $1.2 million in depreciation expense also hurt the overall gross margin. Changes in product mix and selling price also contributed to changes in gross margin. Although the Company anticipates passing on a portion of the higher costs of raw materials through increased selling prices, it is expected that higher raw material prices will continue to pressure gross margin.





In linear motors and related systems, margin compression was mainly attributable to the following factors in addition to higher raw material and labor costs:





1.
Changes in product mix. Sales volumes of higher margin products – oil pumps and propulsion systems for coal transportation trains – declined in the first six months of 2011 compared with the same period a year ago, while sales volumes of lower margin products increased significantly.




41


2.
Lower unit selling prices for certain products. In order to expand our customer base and gain market share, we lowered selling prices for certain products.





In specialty micro motors, lower gross margin was primarily attributable to the following factors in addition to higher raw material and labor costs:





1.
Launch of new products, compared with the first six months of last year. New product launches generally experience higher manufacturing costs during the start-up stage due to higher costs associated with workforce training, additional test runs, and smaller initial orders, which result in reduced production efficiency.





2.
Changes in product mix. Sales volumes of higher-margin products declined while sales volumes of lower-margin products increased.





In rotary motors, gross margin declined mainly due to higher raw material and labor costs partially offset by higher pricing.





Operating Expenses





Research and development (R&D) expenses increased to $4.8 million in the six months ended June 30, 2011 from $1.0 million in the six months ended June 30, 2010. As technology and R&D are the Company’s long term strategic focus, we have been making every effort to enhance our R&D projects and invest in product and technology development in order to capture additional market share and position the Company well for further growth. The $4.8 million R&D expense in the first six months of 2011 was mostly associated with the development project of a new automated control system for linear servo motors. This development project was initiated in March 2010 in collaboration with a research institute. It has received extensive interest from potential customers. This project is near its successful completion and a total of $3.5 million expense was incurred in the first six months of this year.





Selling, general and administrative expenses (SG&A) amounted to $23.9 million and $14.3 million in the first six months of 2011 and 2010, respectively, or 10.1% and 6.8% of each period’s total revenues. The year-over-year increase in SG&A primarily reflected the following additional expenses compared to the same period of last year:





1.
Expense related to advances on inventory purchases totaling $2.5 million that were written off due to vendors business failures.





2.
Expense related to allowance for bad debts increased by $1.9 million in the first six months of 2011, based on accounts receivable aging analysis.





3.
Expenses in the first six months of 2011 related to the Going Private process (see section titled “Recent Events”) totaled approximately $4.1 million. This amount included legal fees associated with the class action lawsuits (see Part II, Item 1 “Legal Proceedings”), fees associated with legal and financial advisors for the Special Committee of the Board of Directors, and other related expenses. The Company expects to recover some of the legal expenses related to the class action lawsuits pursuant to its insurance policy.





4.
Shipping and handling costs increased to $2.8 million from $2.0 million in the same period of last year. The higher shipping and handling costs were mainly attributable to higher sales, higher fuel costs, and further geographical expansion of our customer base.





Operating profits were $37.7 million and $55.8 million in the first six months of 2011 and 2010, respectively, with operating margin at 16.0% and 26.5%, respectively.





Other Income (net)





Other income was $3.5 million and $2.4 million in the first six months of 2011 and 2010, respectively. Other income mainly included income from recycling scrap materials and selling production waste.





Interest Expense (net)





Net interest expense was $3.2 million and $2.6 million in the six months ended June 30, 2011 and 2010, respectively. Net interest expense in the first six months of 2011 mainly included $3.2 million interest expense, $0.6 million interest income, and $0.5 million of foreign currency transaction loss. Net interest expense in the first six months of 2010 mainly included $1.5 million amortization of debt discount and debt issuance cost, $1.5 million interest expense and $0.4 million interest income.





See Note 15 for a breakdown of interest expense.





Income Taxes





Provision for income tax was $10.2 million and $7.9 million in the first six months of 2011 and 2010, respectively.


42





The corporate income tax rates in 2011 for some of our PRC subsidiaries are higher than in 2010 due to expiration of the previous preferential tax rates approved by the government. Harbin Tech Full was subject to a 10% preferential tax rate in 2010 that expired at the end of 2010. Harbin Tech Full is in the process of applying for a new preferential income tax rate from the Chinese government. Management believes that it is highly likely that Harbin Tech Full will be approved for a 15% preferential income tax rate for 2011. However, since the approval process may take six months or longer, the management of Harbin Tech Full opted for caution and used a 25% standard income tax rate to calculate the provision for income tax for the first six months of 2011. The 25% income tax rate for Harbin Tech Full has caused the provision for income tax at Harbin Tech Full to be significantly higher in the six months ended June 30, 2011 than in the same period of last year. The 10% preferential tax rate as opposed to the 25% standard rate resulted in a $3.4 million savings on tax in the first six months of 2010. Shanghai Tech Full was subject to an 11% preferential tax rate in 2010 and has been granted a 12% preferential tax rate in 2011. Xi’an Tech Full Simo remains at a 15% preferential tax rate in 2011. Weihai Tech Full has been subject to the standard 25% tax rate.





LIQUIDITY AND CAPITAL RESOURCES





Overview





A major factor in the Company’s liquidity and capital resource planning is its generation of operating cash flow, which is strongly dependent on the demand for our products.  This is supplemented by our financing activities in the capital markets including potential debt and equity, which support major acquisitions and capital investments for business growth. In February 2011, the Company entered into a consulting service agreement with a third party which agreed to provide advisory and consulting services to obtain financing in Chinese Capital Market for a period of 5 years from 2011 to 2015. Management expects and plans that the Company will continue to grow rapidly in the next few years organically and/or through acquisitions. To support expected growth, management believes it is critical to maintain adequate access to capital and flexibility to deploy funds in areas needed in a timely fashion when opportunity arises. In the past, the Company relied to a large extent on the U.S. capital markets to provide funds for large capital projects and acquisitions and for the repayment of certain debts. However, management believes that funding opportunities in the U.S. for Chinese companies, particularly those that became public in the U.S. through a reverse merger process, have become difficult after short seller attacks on a number of Chinese companies. Management strongly believes that the Company will need to seek alternative financing sources for the next few years in order to execute its business plan. Given that the Company has most of its operations in China, and funding supply in China has been growing rapidly, it is natural that the Company would consider financial institutions in China. Therefore, we worked out the agreement with a third party that is committed to act in an advisory role to help the Company raise capital over the next five years.





Our liquidity position remains adequate, with $87.6 million in cash and cash equivalents as of June 30, 2011. Cash provided by operating activities totaled $18.4 million in the first six months of 2011, compared with $49.1 million in the same period of 2010. The decrease is mainly due to a decrease in net income (see section titled “Net Income” for the six months ended June 30, 2011 and 2010), and an increase in working capital. Net cash provided by financing activities totaled $9.1 million in the first six months of 2011, mainly from increased short term bank loans and bank notes, partially offset by increased restricted cash required by banks. Capital expenditures generally include plant construction and equipment purchases which totaled approximately $41.0 million in the first six months of 2011.





During the first six months of 2011, several items under our current assets and current liabilities including cash, restricted cash, accounts receivable, advance on inventory purchase, and short term notes payable changed significantly. The $16.3 million increase in restricted cash was primarily due to an increase in short term bank notes payable. Banks in general require a 50% restricted cash amount deposited with the notes issuing bank to secure notes payable. Accounts receivables increased by $14.4 million. Advance on inventory purchases increased by $7.2 million in preparation for anticipated higher production activities.





Cash Position





As of June 30, 2011, we had cash and cash equivalents of $87.6 million, compared with $98.8 million as of December 31, 2010. The following table provides detailed information about our net cash flow for the first six months of 2011, compared to the same period of 2010.




Six Months Ended June 30,2011


2010Net cash provided by operating activities

$
18,429,317


$
49,138,164Net cash used in investing activities


(40,882,120
)


(94,983,376
)Net cash provided by financing activities


9,100,575



(6,939,166
)Effect of exchange rate changes on cash


2,177,278



157,179INCREASE (DECREASE) IN CASH

$
(11,174,950
)

$
(52,627,199
)




43


Operating Activities





Cash provided by operating activities is consolidated net income (net income attributable to both controlling and non-controlling interest) adjusted for non-cash income and expense items and changes in operating assets and liabilities.





Net cash provided by operating activities was $18.4 million in the first six months of 2011, compared with $49.1 million in the first six months of 2010. The decrease is mainly due to a decrease in net income (see section titled “Net Income” for the six months ended June 30, 2011 and 2010), an increase in accounts receivables, and an increase in cash used for inventory purchases.





Investing Activities





Our main uses of cash for investing activities in the first six months of 2011 were for equipment purchase and plant construction including land use right purchase as we continued to invest in upgrading manufacturing capabilities, improving production efficiency, and expanding capacity. Capital expenditures totaled approximately $41.0 million during the first six months of 2011 which also included $23 million prepayment in June to acquire land use rights. Nearly all of these investing activities occurred in the seasonally stronger second quarter. For comparison, total capital expenditures were $40.7 million in the same period last year.





On June 10, 2011, Xi’an Tech Full Simo entered into a land use agreement (the “Simo Land Use Agreement”) with Xi’an Lintong Tourism and Business Development Management Commission (“Xi’an Lintong”) with respect to Simo Motor’s use of 500 Chinese Mu of land (approximately 82.4 acres or 333,500 square meters) located in the Daixin Industrial Development Zone in Xi’an Lintong (the “New Site”). Pursuant to the Simo Land Use Agreement, the New Site will be used for construction of a new manufacturing facility that will produce electric equipment and machinery and related products as part of a capacity expansion project. The term of the Simo Land Use Agreement is 50 years and the aggregate amount that Simo Motor shall pay to Xi’an Lintong is approximately $38.8 million (RMB 250 million). The Company made a pre-payment of $23.0 million (RMB 150 million) as of June 30, 2011 and will pay in full upon receipt of the land use license to be issued by the government.





Financing Activities





Net cash provided by financing activities totaled $9.1 million in the first six months of 2011, mainly from increased short term bank loans and bank notes payable, partially offset by the increased restricted cash required by banks.





On November 22, 2010, the Company entered into a Term Loan Facility Agreement, dated November 22, 2010 (the “CDB Agreement”) with China Development Bank Corporation, Hong Kong Branch (“CDB”) pursuant to which CDB has agreed to provide a USD$35,000,000 loan facility (“Facility A”) and an RMB100,000,000 loan facility (“Facility B,” and collectively with Facility A, the “Facilities”) to the Company (the loans made under Facility A shall be referred to herein as “Facility A Loans” and the loans made under Facility B shall be referred to herein as “Facility B Loans”). The Facility A Loans and the Facility B Loans shall be made pursuant to one or more borrowings from time to time during the period of time from the date of the CDB Agreement to the date falling on the expiration of six (6) months after the date of the CDB Agreement upon delivering a utilization request from the Company to CDB. Interest on Facility A Loans shall be 3% per annum plus LIBOR (as defined in the CDB Agreement). Interest on Facility B Loans shall be 2.5% per annum plus SHIBOR (as defined in the CDB Agreement). The Company is required to repay the Facility A Loans in two (2) equal installments on (i) the date which falls twenty four (24) months after the first utilization date of any loan and (ii) the date which falls thirty six (36) months after the first utilization date of any loan. The Company is required to repay the Facility B Loans in two (2) equal installments on (i) the date which falls twenty four (24) months after the first utilization date of any loan and (ii) the date which falls thirty six (36) months after the first utilization date of any loan.





The CDB Agreement provides that the Company may, upon not less than one month’s prior notice prepay on an Interest Payment Date (as defined in the CDB Agreement) or a Repayment Date (as defined in the CDB Agreement) all or part of any loan (but if in part, in an amount that is an integral multiple of USD$500,000 in the case of a Facility A Loan or RMB 2,000,000 in the case of Facility B Loan). The CDB Agreement also provides that upon a Change of Control (as defined in the CDB Agreement) of the Company, CDB may, by not less than 30 days notice to the Company, cancel the Facilities and declare all outstanding loans, together with accrued interest and all other amounts to be immediately due and payable.





The Company’s obligations under the CDB Agreement are secured by a pledge of shares of common stock of the Company owned by its Chairman and Chief Executive Officer, Tianfu Yang. On November 22, 2010, Mr. Yang entered into a Security and Pledge Agreement (the “Pledge Agreement”) with CDB, pursuant to which, Mr. Yang has agreed to pledge 7,000,000 shares of common stock to CDB to secure the loans. Under the Pledge Agreement, Mr. Yang may also be obliged to pledge to CDB, under certain circumstances, additional shares of common stock owned by him and, to the extent such additional shares are not sufficient, cash.





The Company has maintained compliance with the covenants pursuant to the CDB Agreement.





For the six months ended June 30, 2011, the Company has received proceeds from notes payable – short term of $21.3 million, the short term notes are bank acceptance notes issued by local banks in China that entitle the Company’s suppliers to receive the full face amount from the issuing banks. In China, this is a very common low cost financial instrument used to pay suppliers. The bank notes are secured by a cash deposit (restricted cash) made with the bank in the amount of 50% of the face amount of the bank notes balances. Bank acceptance notes are a low cost financing method and can free up cash for other capital needs. The increase in short term bank notes during the period reflects our increased working capital needs for the purchasing of raw materials as we anticipated increased production volumes.


44


Contractual Obligations





On September 8, 2006, HTFE entered into an agreement (“HTFE Land Use Agreement”) with Shanghai Lingang Investment and Development Company Limited (“Shanghai Lingang”) with respect to HTFE’s lease and use of 40,800 square meters (approximately 10.1 acres) of State-owned land in the Shanghai Zhuqiao Airport Industrial Zone (the “Site”). The term of the land use agreement is 50 years. In June 2009, the Land Use Agreement was revised with the land size increased to a total of approximately 53,000 square meters (approximately 13.1 acres). The aggregate amount HTFE shall pay to Shanghai Lingang is approximately $6.28 million (RMB42.84 million) ("Fee"), approximately 96.8% or $6.1 million (RMB 41.56 million) had been paid as of June 30, 2011 with the balance payable in installments.





On August 25, 2010, the Company entered into an agreement with Shelton Technology, LLC.  Under the terms of the agreement, the Company is required to contribute a total of $1 million to AAG prior to December 31, 2011.





The Company enters into non-cancellable purchase commitments with some of its vendors. As of June 30, 2011 and December 31, 2010, the Company was obligated under the non-cancellable commitments to purchase materials totaling to $6,977,242 and $12,000,496, respectively. These commitments are short-term and expire within one year. The Company has not experienced losses on these purchase commitments over the years.





In March 2011, STFE increased the registered capital by $5.92 million from approximately $10 million to $15.9 million, 33% of the increase in registered capital has been injected into STFE on April 7, 2011. The remaining 67% of the increase in registered capital, which amounted to $3.9 million, is required to be injected into STFE on or before April 7, 2013.





On June 10, 2011, Simo Motor entered into a land use agreement (the “Simo Land Use Agreement”) with Xi’an Lintong Tourism and Business Development Management Commission (“Xi’an Lintong”) with respect to Simo Motor’s use of 500 Chinese Mu of land (approximately 82.4 acres or 333,500 square meters) located in the Daixin Industrial Development Zone in Xi’an Lintong (the “New Site”). Pursuant to the Simo Land Use Agreement, the New Site will be used for construction of a new manufacturing facility that produces electric equipment and machinery related products as part of a capacity expansion project. The term of the Simo Land Use Agreement is 50 years and the aggregate amount that Simo Motor shall pay to Xi’an Lintong is approximately $38.8 million (RMB 250 million). The Company made a pre-payment of $23.0 million (RMB 150 million) as of June 30, 2011 and will pay in full upon receipt of the land use license to be issued by the government.





Off-balance Sheet Arrangements





We do not have any off-balance sheet arrangements.





Item 3. Quantitative and Qualitative Disclosures about Market Risk





Information relating to quantitative and qualitative disclosures about market risk is provided in the Company’s 2010 Annual Report on Form 10-K, which information is incorporated herein by reference. There have been no material changes in the Company’s exposure to market risk since December 31, 2010.





Item 4. Controls and Procedures





(a) Evaluation of Disclosure Controls and Procedures





We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules, regulations and related forms, and that such information is accumulated and communicated to our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.





Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2011, as such term is defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based on this evaluation, our principal executive officer and principal financial officer have concluded that during the period covered by this report, the Company’s disclosure controls and procedures are effective as of such date at a reasonable assurance level to ensure that information required to be disclosed by us in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.




45


(b) Changes in Internal Control over Financial Reporting





There have been no changes in our internal control over financial reporting that occurred during the six months ended June 30, 2011 covered by this Quarterly Report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.





PART II. OTHER INFORMATION





Item 1. Legal Proceedings





Eleven shareholder class action lawsuits were filed against the Company and/or certain officers and the members of its Board of Directors (the “Board”), in connection with the October 10, 2010 non-binding proposal made by the Company’s Chairman and Chief Executive Officer, Mr. Tianfu Yang, and Baring Private Equity Asia Group Limited to acquire all of the outstanding shares of the Company’s Common Stock not currently owned by Mr. Yang and his affiliates for $24.00 per share in cash, as further described in the Schedule 13D/A and Exhibits thereto filed on October 12, 2010 (the “Proposal”). Six actions were filed in Nevada state court (Carson City, Clark County, or Washoe County); two actions were filed in Nevada federal district court; and three actions were filed in New York state court. All of the actions assert claims against the Company and/or members of the Board for allegedly breaching their fiduciary duties in connection with the Proposal, as described further below.





On or about October 19, 2010, the Company became aware that the first of the shareholder class actions had been filed against the Company and its Board members in connection with the Proposal. Plaintiffs allege, among other things, that the proposed buyout price and the process of evaluating the Proposal are unfair and inadequate. Plaintiffs seek, among other relief, to enjoin defendants from consummating the Proposal and to direct defendants to exercise their fiduciary duties to obtain a transaction that is in the best interests of the Company’s shareholders.





The Nevada State Court Litigation





As detailed below, the Company moved to dismiss, transfer, or stay Plaintiffs’ actions and to consolidate them before the Nevada Business Court. The Company's motions to transfer the Carson City actions to Clark County were granted, and the actions have been consolidated with the related actions pending before the Clark County Business Court. The consolidated action is captioned, In re Harbin Electric, Inc. Shareholder Litigation, Case No. A-11-627656-C (the “Nevada Action”).





Following the announcement of the Merger Agreement and the filing of the Preliminary Merger Proxy, on July 20, 2011, Plaintiffs in the Nevada Action filed a consolidated amended class action complaint.  Plaintiffs assert claims against the Company’s Board for alleged breaches of their fiduciary duties to the Company’s shareholders. Plaintiffs allege, among other things, that the Board has failed to maximize the value of Harbin to its shareholders and that the Preliminary Merger Proxy fails to disclose material information.  Plaintiffs seek, among other relief, to enjoin defendants from consummating the Proposal until the Company implements a process to obtain the most favorable terms for Harbin’s shareholders, and to rescind the Merger Agreement and the Proposal to the extent already implemented.





On August 1, 2011, Plaintiffs in the Nevada Action filed a motion for preliminary injunction against the Company and the Board. Plaintiffs seek to enjoin the Company and the Board from soliciting proxy votes and from conducting any shareholder meeting to approve the Merger Agreement.  The parties are engaged in expedited discovery.  A hearing on Plaintiffs’ motion for preliminary injunction is set for September 19, 2011.





The Nevada Federal Court Litigation





As detailed below, both of the actions pending in Nevada federal district court have been dismissed.





The New York State Court Litigation





The New York actions (Yun, Gould and Norfolk) were consolidated under the caption, In re Harbin Shareholders Litigation, Index No. 35327/10. Plaintiffs’ counsel thereafter filed a consolidated amended complaint naming only the Company and Tianfu Yang as defendants. The Company and Mr. Yang have moved to dismiss or, in the alternative, to stay the New York action in deference to the litigation proceeding in the Nevada Business Court. Those motions have not yet been decided by the Court. The Company has reviewed the allegations contained in the complaints and believes they are without merit.  The Company intends to defend the litigation vigorously.





The pending cases are listed below.





Kay Hurewitz v. Harbin Electric, Inc. et al., No. 10-OC-00489-1B (“Hurewitz”), filed in the First Judicial District Court of the State of Nevada in and for Carson City on October 13, 2010. The complaint named the Company and Board members Tianfu Yang, Ching Chuen Chan, Boyd Plowman, David Gatton, Yunyue Ye, and Lanxiang Gao as defendants. This action has now been transferred to Clark County and consolidated with the cases there.





Bertrand Sellier v. Harbin Electric, Inc. et al., No. 3:10-CV-00645 (“Bertrand”), filed in the United States District Court for the District of Nevada on October 13, 2010. The complaint named the Company and Board members Tianfu Yang, Ching Chuen Chan, Boyd Plowman, David Gatton, Yunyue Ye, and Lanxiang Gao as defendants. The plaintiff filed a notice of voluntary dismissal of his action without prejudice and the action has been dismissed.


46





Norfolk County Retirement System v. Harbin Electric, Inc. and Tianfu Yang (“Norfolk”), No. 10-35327, filed in the Supreme Court of the State of New York, Suffolk County on October 15, 2010. The complaint named the Company and Tianfu Yang as defendants.





Luis Necuze v. Harbin Electric, Inc. et al., No. A-10-627425 (“Necuze”), filed in the Eighth Judicial District Court for the State of Nevada in and for Clark County on October 15, 2010. The complaint named the Company, Board members Tianfu Yang, Ching Chuen Chan, Boyd Plowman, David Gatton, Yunyue Ye, and Lanxiang Gao, and Baring Private Equity Asia Group, Ltd. as defendants. This action has been voluntarily dismissed as moot because the plaintiff no longer is a stockholder.





Jack M. Ebner v. Harbin Electric, Inc. et al., No. A-11-644021-C (“Ebner”), filed in the Eighth Judicial District Court of Clark County, Nevada on June 27, 2011.  The complaint named the Company and Board members Tianfu Yang, Lanxiang Gao, Ching Chuen Chan, Boyd Plowman, Yunyue Ye, and David Gatton as defendants. This action has been consolidated with the related actions pending in Clark County.





Jacqueline Elliott v. Harbin Electric, Inc. et al., No. A-10-627656-C (“Elliott”), filed in the Eighth Judicial District Court for the State of Nevada in and for Clark County on October 19, 2010. The complaint named the Company and Board members Tianfu Yang, Ching Chuen Chan, Boyd Plowman, David Gatton, Yunyue Ye, and Lanxiang Gao as defendants.





George Yun v. Harbin Electric, Inc. et al., No. 10-39805 (“Yun”), filed in the Supreme Court of the State of New York, Suffolk County) on October 22, 2010. The complaint named the Company and Board members Tianfu Yang, Ching Chuen Chan, Boyd Plowman, David Gatton, Yunyue Ye, and Lanxiang Gao as defendants. All of the defendants other than the Company and Mr. Yang have been voluntarily dismissed by Plaintiff.





Randolph Fisher v. Harbin Electric, Inc. et al., No. 10-OC-00498-1B (“Fisher”), filed in the First Judicial District Court for the State of Nevada in and for Carson City on October 22, 2010. The complaint named the Company and Board members Tianfu Yang, Ching Chuen Chan, Boyd Plowman, David Gatton, Yunyue Ye, and Lanxiang Gao as defendants. This action has now been transferred to Clark County and consolidated with the cases there.





Gerald Gould v. Tianfu Yang, No. 10-40004 (“Gould”), filed in the Supreme Court of the State of New York Suffolk County on October 25, 2010. The complaint named Tianfu Yang as a defendant.





Mark Rosen v. Harbin Electric, Inc. et al., No. 11-OC-00036-1B (“Rosen”), filed in the Second Judicial District Court for the State of Nevada in and for Washoe County on October 28, 2010. The complaint named the Company, Board members Tianfu Yang, Ching Chuen Chan, Boyd Plowman, David Gatton, Yunyue Ye, and Lanxiang Gao, and Baring Private Equity Asia Group, Ltd. as defendants. Plaintiff voluntarily dismissed the Company from this action and moved to transfer the action to the Eighth Judicial District Court of the State of Nevada in and for Carson City, which motion was granted. This action has now been transferred to Clark County and consolidated with the cases there.





Patrick Sweeney v. Harbin Electric, Inc. et al., No. 3:10-CV-00685 (“Sweeney”), filed in the United States District Court for the District of Nevada on November 11, 2010. The complaint named the Company and Board members Tianfu Yang, Ching Chuen Chan, Boyd Plowman, David Gatton, Yunyue Ye, and Lanxiang Gao as defendants. Defendants’ motion to dismiss the action has been granted, the case dismissed, and the action closed.





Item 1A. Risk Factors





An investment in our common stock is very risky. You should carefully consider the risk factors described below before making an investment decision. If any of the following risks actually occurs, our business, financial condition or operating results could be materially and adversely affected. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment. Additional risks and uncertainties not currently foreseeable to us may also impair our business operations.





GENERAL RISKS RELATING TO OUR BUSINESS





Our rapid growth may strain our resources.





Our revenues increased by 25% from the second quarter of 2010. Our revenues increased by 91% for the year ended December 31, 2010 versus the year ended December 31, 2009, and 85% in 2009 over 2008. However, it is unlikely that we will maintain such growth in the long term and cannot assure any growth of our business for any period. Our rapid expansion will place significant strain on our management and our operational, accounting, and information systems. We expect that we will need to continue to improve our financial controls, operating procedures, and management information systems. We will also need to effectively hire, train, motivate, and manage our employees. Our failure to manage our growth could disrupt our operations and ultimately prevent us from generating the profits we expect.




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Our debt may constrict our operations, and cash flows and capital resources may be insufficient to make required payments on our indebtedness and future indebtedness.





As of June 30, 2011, we had a $35 million loan facility and an RMB100 million (approximately $15 million) loan facility under a Term Loan Facility Agreement with China Development Bank Corporation Hong Kong Branch as lender (“CDB”). Additionally, our PRC subsidiaries had a total of approximately $36.9 million short term loans outstanding as of June 30, 2011. These loans were obtained from local PRC banks and unrelated third parties.  These obligations could have important consequences to you. For example, they could:





·
reduce the availability of our cash flow to fund future working capital, capital expenditures, acquisitions and other general corporate purposes;


·
limit our ability to obtain additional financing for working capital, capital expenditures, and other general corporate requirements;


·
increase our vulnerability to general adverse economic and industry conditions;


·
require us to sell assets to reduce indebtedness or influence our decisions about whether to do so;


·
expose us to interest rate fluctuations because the interest rates for the two loan facilities are variable; and


·
place us at a competitive disadvantage compared to competitors that may have proportionately less debt.





In addition, our ability to make scheduled payments or refinance our obligations depends on our successful financial and operating performance, cash flows, and capital resources, which in turn depend upon prevailing economic conditions and certain financial, business, and other factors, many of which are beyond our control. If our cash flows and capital resources are insufficient to fund our debt obligations, we may be forced to reduce or delay capital expenditures, sell material assets or operations, obtain additional capital, restructure our debt, or declare bankruptcy. In the event that we are required to dispose of material assets or operations to meet our debt service and other obligations, the value realized on such assets or operations will depend on market conditions and the availability of buyers. Accordingly, we may be forced to sell at an unfavorable price. We may be unable to obtain financing or sell assets on satisfactory terms, or at all, which could cause us to default on our debt service obligations and be subject to foreclosure on such loans.





Additionally, we could incur additional indebtedness in the future and, if new debt is added to our current debt levels, the risks above could intensify.





Covenants in the CDB Agreement may restrict our ability to engage in or enter into a variety of transactions.





The Term Loan Facility Agreement (the “CDB Agreement”), dated as of November 22, 2010, between us and CDB   as lender, contains various covenants that may limit our discretion in operating our business. In particular, we are limited in our ability to, among other things, create liens on our assets, merge, consolidate, transfer substantially all of our assets, give guarantees or indemnities, engage in any transaction that results in Mr. Yang and certain of his affiliates being the beneficial owner of less than 30% of our outstanding common stock, and engage in certain transactions that result in a change in the majority of our Board of Directors from those in office on the date of the CDB Agreement. These covenants could have an adverse effect on our business by limiting our ability to take advantage of financing, merger and acquisition or other corporate opportunities.





A covenant in the CDB Agreement may cause the facility be cancelled upon 30 days notice at the discretion of the Lender.





Pursuant to the CDB Agreement, if a Change of Control of our company occurs, at the discretion of CDB, the facilities may be cancelled and all outstanding amounts under such facilities may become immediately due and payable with no less than 30 days notice.  For purposes of the CDB Agreement, a Change of Control shall be deemed to occur if (i) our chairman and chief executive officer, Mr. Tianfu Yang, ceases to be the beneficial owner, directly or indirectly, of at least thirty percent of our outstanding capital stock, (ii) we merge, consolidate, sell substantially all of our assets in a transaction other than with Mr. Tianfu Yang and certain of his affiliates, (iii) individuals who on the date of the CDB Agreement constitute our Board of Directors  (together with any  new directors  whose election  or appointment by such board or whose nomination for election by our shareholders is approved by a vote of not less than three-fourths of the directors then still in office who are either directors on the date of the CDB Agreement or whose election or nomination for election has been previously so approved) cease for any reason to constitute a majority of our Board of Directors then in office or (iv) our shareholders approve a plan of liquidation or dissolution.





A default in our Term Loan Facility Agreement may cause CDB to foreclose on the pledge of common stock made by Mr. Yang as security for our obligations under the Term Loan Agreement, which could result in a change of control of our company.





Our obligations under the CDB Agreement are secured by a pledge of shares of common stock of the Company owned by its Chairman and Chief Executive Officer, Tianfu Yang.  On November 22, 2010, Mr. Yang entered into a Security and Pledge Agreement (the “Pledge Agreement”) with CDB, pursuant to which, Mr. Yang agreed to pledge 7,000,000 shares of common stock to CDB to secure the loans.  Under the Pledge Agreement, Mr. Yang may also be obliged to pledge to CDB, under certain circumstances, additional shares of common stock owned by him and, to the extent such additional shares are not sufficient, cash.  In the event that we were to default on the CDB Agreement and CDB were to foreclose on the shares pledged by Mr. Yang and cause such shares to be sold in order to satisfy our obligations under the CDB Agreement, this could result in a change of control of our company.


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Our success depends on our management team and other key personnel, the loss of any of whom could disrupt our business operations.





Our future success will depend in substantial part on the continued service of the members of our senior management. The loss of the services of one or more of our key personnel could impede implementation of our business plan and result in reduced profitability. We do not carry key person life insurance on any of our officers or employees. Our future success will also depend on the continued ability to attract, retain and motivate highly qualified technical sales and marketing customer support.





Because of the rapid growth of the economy in China, competition for qualified personnel is intense. We cannot assure you that we will be able to retain our key personnel or that we will be able to attract, assimilate or retain qualified personnel in the future.





We depend on the supply of raw materials and key component parts, and any adverse changes in such supply or the costs of raw materials may adversely affect our operations.





No vendor accounted for more than 10% of the raw material purchases for the three months and six months ended June 30, 2011 and 2010. Any material change in the spot and forward rates could have a material adverse effect on the cost of our raw materials and on our operations. In addition, if we need alternative sources for key component parts for any reason, these component parts may not be immediately available to us. If alternative suppliers are not immediately available, we will have to identify and qualify alternative suppliers, and production of these components may be delayed. We may not be able to find an adequate alternative supplier in a reasonable time period or on commercially acceptable terms, if at all. Shipments of affected products have been limited or delayed as a result of such problems in the past, and similar problems could occur in the future. An inability to obtain our key source supplies for the manufacture of our products might require us to delay shipments of products, harm customer relationships or force us to curtail or cease operations.





We may experience material disruptions to our manufacturing operation.





While we seek to operate our facilities in compliance with applicable rules and regulations and take measures to minimize the risks of disruption at our facilities, a material disruption at one of our manufacturing facilities could prevent us from meeting customer demand, reduce our sales and/or negatively impact our financial results. Any of our manufacturing facilities, or any of our machines within an otherwise operational facility, could cease operations unexpectedly due to a number of events, including:





·
unscheduled maintenance outages;


·
prolonged power failures;


·
an equipment failure;


·
disruptions in the transportation infrastructure including roads, bridges, railroad tracks;


·
fires, floods, earthquakes, or other catastrophes; and


·
other operational problems.





We may not be able to adequately protect and maintain our intellectual property, which could weaken our competitive position.





Our success will depend on our ability to continue to develop and market electric motor products. We have been granted 20 patents in China relating to linear motor and automobile specialty micro-motor applications. No assurance can be given that such patents will not be challenged, invalidated, infringed or circumvented, or that such intellectual property rights will provide a competitive advantage to us. The implementation and enforcement of PRC intellectual property laws historically have not been vigorous or consistent, primarily because of ambiguities in the PRC laws and a relative lack of developed enforcement mechanisms. Accordingly, intellectual property rights and confidentiality protections in the PRC are not as effective as in the United States and other countries. Policing the unauthorized use of proprietary technology is difficult and expensive, and we might need to resort to litigation to enforce or defend patents issued to us or to determine the enforceability, scope and validity of our proprietary rights or those of others. Such litigation will require significant expenditures of cash and management efforts and could harm our business, financial condition and results of operations. An adverse determination in any such litigation will impair our intellectual property rights and may harm our business, competitive position, business prospects and reputation. In addition, since we have chosen to secure patents only in China, we may not be in a position to protect our inventions and technology in other countries in which we sell our product, which could result in increased competition and lower pricing for our products.





We rely on the services of our SEC reporting manager to assist us in researching and resolving certain US GAAP accounting issues and preparing our consolidated financial statements.





We employ an SEC Reporting Manager who is a Certified Public Accountant in the United States to assist our internal accounting and finance personnel in resolving complex US GAAP accounting issues. From time to time we rely on her to conduct research on complex accounting issues relating to US GAAP and to provide advice to the Company as to how to comply with US GAAP. Although our SEC Reporting Manager is not involved in our day to day operations or the management of our accounting functions, she also assists us in our consolidation process and in preparing our consolidated financial statements and footnotes. If we were to lose the services of our SEC Reporting Manager, we would attempt to hire another similarly qualified person to replace her. The loss of the services of our SEC Reporting Manager, in the absence of a qualified replacement, could adversely impact our ability to accurately prepare our consolidated financial statements on a timely basis.


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RISKS RELATING TO DOING BUSINESS IN THE PEOPLE’S REPUBLIC OF CHINA





China’s economic policies could adversely affect our business.





Substantially all of our assets are located in China and substantially all of our revenues are derived from our operations in China. Accordingly, our results of operations and prospects are subject, to a significant extent, to economic, political and legal developments in China.





While China’s economy has experienced significant growth in the past 30 years, it has been uneven, both geographically and among various sectors of the economy. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall economy of China, but may also have a negative effect on us. For example, our operating results and financial condition may be adversely affected by government control over capital investments or changes in tax regulations.





The economy of China has been changing from a planned economy to a more market-oriented economy. In recent years the Chinese government has implemented measures emphasizing market forces for economic reform, reduction of state ownership of productive assets, and establishment of corporate governance in business enterprises; however, a substantial portion of productive assets in China are still owned by the Chinese government. In addition, the Chinese government continues to play a significant role in regulating industry development by imposing industrial policies. It also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy, and providing preferential treatment to particular industries or companies.





PRC laws and regulations governing our current business operations are sometimes vague and uncertain and any changes in such laws and regulations may harm our business.





There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations including, but not limited to, the laws and regulations governing our business, and the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy and criminal proceedings. We are considered foreign persons or foreign funded enterprises under PRC laws and, as a result, we are required to comply with PRC laws and regulations. These laws and regulations are sometimes vague and may be subject to future changes, and their official interpretation and enforcement may involve substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental reliance. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our business.





Inflation in the PRC could negatively affect our profitability and growth.





The PRC economy has experienced rapid growth. Rapid economic growth could lead to growth in the money supply and rising inflation. If prices for our products rise at a rate that is insufficient to compensate for the rise in the cost of supplies, it may harm our profitability. In order to control inflation in the past, the PRC government has imposed controls on bank credit, limits on loans for fixed assets and restrictions on state bank lending. Such policies can lead to a slowing of economic growth. Rises in interest rates by the central bank would likely slow economic activity in China which could, in turn, materially increase our costs and also reduce demand for our products.





PRC regulations relating to mergers, offshore companies, and Chinese stockholders, if applied to us, may limit our ability to operate our business as we see fit.





Regulations govern the process by which we may participate in an acquisition of assets or equity interests. Depending on the structure of the transaction, the new regulation will require Chinese parties to make a series of applications and supplemental applications to various government agencies. In some instances, the application process may require the presentation of economic data concerning a transaction, including appraisals of the target business and evaluations of the acquirer, which are designed to allow the government to assess the transaction. Government approvals will have expiration dates by which a transaction must be completed and reported to the government agencies. Compliance with the new regulations is likely to be more time consuming and expensive than in the past and the government can now exert more control over the combination of two businesses. Accordingly, due to the PRC regulations, our ability to engage in business combination transactions in China through our Chinese subsidiaries has become significantly more complicated, time consuming and expensive, and we may not be able to negotiate transactions that are acceptable to us or sufficiently protective of our interests in a transaction.


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If preferential tax concessions granted by the PRC government change or expire, our financial results and results of operations would be materially and adversely affected.





Our results of operation may be adversely affected by changes to or expiration of preferential tax concessions that our Chinese subsidiaries currently enjoy. The statutory tax rate generally applicable to domestic Chinese companies is generally 25%. The PRC government provides reduced tax rates for productive foreign investment enterprises in the Economic and Technological Development Zones and for enterprises engaged in production or business operations in the Special Economic Zones or in certain industries.  These preferential tax rates are generally graduated, starting at 0% and increasing to the standard EIT rate of 25% over time.  Harbin Tech Full was granted a 10% preferential tax rate from 2008 to 2010 due to its location in a specially designated economic region that  expired on December 31, 2010. While applying for the next level of 15% preferential tax treatment, Harbin Tech Full is currently using 25% standard income tax rate until the application is approved. Shanghai Tech Full was subject to an 11% preferential tax rate in 2010 and has been granted a 12% preferential tax rate in 2011. Xi’an Tech Full Simo remains at a 15% preferential tax rate in 2011. Weihai Tech Full has been subject to the standard 25% tax rate. As a result, the estimated tax savings for the three months and six months ended June 30, 2011 amounted to $653,980 and $862,743, respectively. Tax laws in China are subject to interpretations by relevant tax authorities. Preferential tax rates may not remain in effect or may change, in which case we may be required to pay the higher income tax rate generally applicable to Chinese companies, or such other rate as is required by the laws of China.





Fluctuation in the value of the RMB may have a material adverse effect on your investment.





The value of RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. Our revenues and costs are mostly denominated in RMB. Any significant fluctuation in value of RMB may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of our stock in U.S. dollars. For example, an appreciation of RMB against the U.S. dollar would make any new RMB denominated investments or expenditures more costly to us, to the extent that we need to convert U.S. dollars into RMB for such purposes. In addition, the depreciation of significant U.S. dollar denominated assets could result in a charge to our income statement and a reduction in the value of these assets.





Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. We do not have any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.





We must comply with the Foreign Corrupt Practices Act.





We are required to comply with the United States Foreign Corrupt Practices Act, which prohibits U.S. companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some of our competitors, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in mainland China. If our competitors engage in these practices, they may receive preferential treatment from personnel of some companies, giving our competitors an advantage in securing business or from government officials who might give them priority in obtaining new licenses, which would put us at a disadvantage. Although we inform our personnel that such practices are illegal, we cannot assure you that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we will take timely and appropriate action, but we could suffer severe penalties.





The Chinese government exerts substantial influence over the manner in which we must conduct our business activities.





Our ability to operate in China may be harmed by changes in its laws and regulations, including those related to taxation, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of these jurisdictions may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations and interpretations. Government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof, and could require us to divest ourselves of any interest we then hold in Chinese properties.





We are subject to environmental laws and regulations in the PRC.





We are subject to environmental laws and regulations in the PRC. Any failure by us to comply fully with such laws and regulations will result in us being subject to penalties and fines or being required to pay damages. Although we believe we are currently in compliance with the environmental regulations in all material respects, any change in the regulations may require us to acquire equipment or incur additional capital expenditure or costs in order to comply with such regulations. Our profits will be adversely affected if we are unable to pass on such additional costs to our customers.





We may have difficulty establishing adequate management, legal and financial controls in the PRC.





The PRC historically has been deficient in Western style management and financial reporting concepts and practices, as well as in modern banking, computer and other control systems. We may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet applicable Western standards.


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If we fail to maintain an effective system of internal control over financial reporting, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our common stock may be adversely affected.





We and our independent registered public accounting firm, in connection with management's assessment of and the audit of our internal control over financial reporting as of December 31, 2010, identified five material weaknesses in our internal control over financial reporting. The material weakness identified were attributable to Xi’an Simo, a former State-Owned-Enterprise ("SOE") the Company acquired in October 2009, which rendered our internal control over financial reporting ineffective on the consolidated level.  Despite significant improvements achieved in its internal control systems, due to its very short history of being part of a U.S. public company, large size, many subsidiaries located away from its headquarters, and limited time to integrate it with the Company, material weaknesses in its internal control over financial reporting were not completely eliminated at Xi’an Simo as of December 31, 2010. The material weaknesses identified by the management at Xi’an Simo are described below.





·
Control activities related to bank reconciliation – At Xi’an Simo, the bank reconciliation for various bank accounts was not prepared accurately which impacted the valuation and existence of the cash in bank as of December 31, 2010.


·
Control activities related to the reconciliation and classification of notes receivable – At Xi’an Simo, notes receivables endorsed as payment to third parties were not properly recorded, resulting in a discrepancy between the physical notes receivables on hand and the general ledger. Additionally, the improper classifications of transactions has impacted the completeness, and valuation of accounts payable / advance to suppliers and notes receivable balances at the year ended December 31, 2010 at Xi’an Simo.


·
Control activities related to the calculation of provision of income tax – At Xi’an Simo, due to ambiguities in the PRC tax rules, the temporary and permanent differences in tax amounts were not properly identified.


·
Control activities related to valuation of inventory allowance – At Xi’an Simo, slow moving inventories that had not been used over a year were not properly evaluated for inventory allowance.


·
Control activities related to inventory recording –– At Xi’an Simo, inventory movement between manufacturing facilities and sales entities were not timely and properly recorded on the general ledger.





A "material weakness" is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis. We have taken measures and plan to continue to take measures to remedy these deficiencies. However, the implementation of these measures may not fully address the control deficiencies in our internal control over financial reporting. Our failure to address any control deficiency could result in inaccuracies in our financial statements and could also impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis. Moreover, effective internal control over financial reporting is important to prevent fraud. As a result, our business, financial condition, results of operations and prospects, as well as the trading price of our common stock, may be materially and adversely affected.





It will be extremely difficult to acquire jurisdiction and enforce liabilities against our officers, directors and assets based in the PRC.





Because most of our executive officers and several of our directors, including our chairman of the Board of Directors, are Chinese citizens, it may be difficult, if not impossible, to acquire jurisdiction over these persons in the event a lawsuit is initiated against us and/or our officers and directors by a stockholder or group of stockholders in the United States. Also, because the majority of our assets are located in the PRC, it would also be extremely difficult to access those assets to satisfy an award entered against us in the U.S. court.





The legal system in China has inherent uncertainties that may limit the legal protections available in the event of any claims or disputes with third parties.





The legal system in China is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since 1979, the central government has promulgated laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. As China’s foreign investment laws and regulations are relatively new and the legal system is still evolving, the interpretation of many laws, regulations and rules is not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit the remedies available in the event of any claims or disputes with third parties. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.





RISKS ASSOCIATED WITH OUR COMMON STOCK





There are risks and uncertainties associated with our proposed merger with Tech Full Electric Company Limited and Tech Full Electric Acquisition Inc.





As previously announced, on June 19, 2011, the Company entered into an Agreement and Plan of Merger, dated June 19, 2011 (“Merger Agreement”), with Tech Full Electric Company Limited, a Cayman Islands exempted company with limited liability, wholly owned indirectly by Mr. Tianfu Yang, the Company’s Chairman and Chief Executive Officer (“Parent”) and Tech Full Electric Acquisition, Inc., a Nevada corporation and a wholly-owned subsidiary of Parent (“Merger Sub”).


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Pursuant to the Merger Agreement, upon the terms and subject to the conditions thereof, at the effective time of the merger, Merger Sub will be merged with and into the Company, the Company will become a wholly-owned subsidiary of the Parent and each of the Company’s shares of common stock issued and outstanding immediately prior to the effective time of the merger (the “Shares”) will be converted into the right to receive $24.00 in cash without interest, except for Shares owned by Parent and Merger Sub (including shares to be contributed to Parent by Mr. Tianfu Yang, affiliates of Abax Global Capital (“Abax”) and certain of the Company’s employees and officers (collectively, the “Purchasing Group”) prior to the effective time of the merger pursuant to a contribution agreement between Parent, each member of the Purchasing Group and Tianfu Investments Limited, a Cayman Islands company directly owning 100% of the equity interest in Parent). Currently, the Purchasing Group collectively beneficially owns approximately 40.39% of the Company’s outstanding shares of common stock.





The Merger Agreement includes customary termination provisions for both the Company and Parent. If the Merger Agreement is terminated under certain circumstances, the Company will be required to pay Parent a termination fee of $22,500,000. If the Merger Agreement is terminated under certain other circumstances, Parent will be required to pay the Company a termination fee equal to $30,000,000.





There are a number of risks and uncertainties relating to the proposed merger. For example, the merger may not be consummated or may not be consummated in the timeframe or manner currently anticipated, as a result of several factors, including, among other things, the failure of one or more of the Merger Agreement’s closing conditions, Parent’s failure or litigation relating to the merger. In addition, there can be no assurance that approval of our stockholders will be obtained, that the other conditions to closing of the merger will be satisfied or waived or that other events will not intervene to delay or result in the termination of the merger. If the merger is not completed, the price of our common stock may change to the extent that the current market price of our common stock may reflect an assumption that the merger will be consummated.





Pending the closing of the merger, the Merger Agreement also restricts us from engaging in certain actions without Parent’s consent, which could prevent us from pursuing opportunities that may arise prior to the closing of the merger. Any delay in closing or a failure to close could have a negative impact on our business and stock price as well as our relationships with our customers, vendors or employees, as well as a negative impact on our ability to pursue alternative strategic transactions and/or our ability to implement alternative business plans.





Our business could be adversely impacted as a result of uncertainty related to the proposed merger.





The proposed merger could cause disruptions to our business or business relationships, which could have an adverse impact on our financial condition, results of operations and cash flows. For example:





·
the attention of our management may be directed to transaction-related considerations and may be diverted from the day-to-day operations of our business;


·
our employees may experience uncertainty about their future roles with us, which might adversely affect our ability to retain and hire key personnel and other employees; and


·
customers, suppliers or other parties with which we maintain business relationships may experience uncertainty about our future and seek alternative relationships with third parties or seek to alter their business relationships with us.





In addition, we have incurred, and will continue to incur, significant costs, expenses and fees for professional services and other transaction costs in connection with the merger, and many of these fees and costs are payable by us regardless of whether or not the merger is consummated.





Our common stock may be affected by limited trading volume and may fluctuate significantly.





Our common stock is traded on the Nasdaq Global Select Market. Although an active trading market has developed for our common stock, there can be no assurance that an active trading market for our common stock will be sustained. Failure to maintain an active trading market for our common stock may adversely affect our stockholders’ ability to sell our common stock in short time periods, or at all. In addition, sales of substantial amounts of our common stock in the public market could harm the market price of our common stock. Our common stock has experienced, and may experience in the future, significant price and volume fluctuations, which could adversely affect the market price of our common stock.





We do not anticipate paying cash dividends on our common stock in the foreseeable future.





We do not anticipate paying cash dividends in the foreseeable future. Presently, we intend to retain all of our earnings, if any, to finance development and expansion of our business. The Indenture pursuant to which the Notes were issued prohibits us from paying any dividends on our capital stock while the Notes remain outstanding. PRC capital and currency regulations may also limit our ability to pay dividends. Consequently, the only opportunity for investors to achieve a positive return on your investment in us will be if the market price of our common stock appreciates.


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Our directors and officers control approximately one third of our common stock and, as a result, they may exercise some voting control and be able to take actions that may be adverse to your interests.





Our directors and executive officers, directly or through entities that they control, beneficially owned, as a group, approximately 34.99% of our issued and outstanding common stock as of June 30, 2011. This concentration of share ownership may adversely affect the trading price of our common stock because investors often perceive a disadvantage in owning shares in a company with one or several controlling stockholders. Furthermore, our directors and officers, as a group, have the ability to significantly influence the outcome of all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, such as mergers, consolidations or the sale of substantially all of our assets. This concentration of ownership may have the effect of delaying or preventing a change of control, including a merger, consolidation or other business combination involving us, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control.





Your percentage ownership in us may be diluted by future issuances of capital stock, which could reduce your influence over matters on which stockholders vote.





Subject to any applicable stockholder approval requirements imposed by the Nasdaq Stock Market, our board of directors has the authority to issue all or any part of our authorized but unissued shares of common stock. Issuances of common stock would reduce your influence over matters on which our stockholders vote.





Item 2. Unregistered Sales of Equity Securities and Use of Proceeds





None.





Item 3. Defaults upon Senior Securities





None.





Item 4. (Removed and Reserved)





Item 5. Other Information





Item 6. Exhibits.





The exhibits listed on the Exhibit Index are being furnished with this report.


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SIGNATURES





Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.




Harbin Electric, Inc.Date: August 9, 2011
By:
/s/ Tianfu YangTianfu YangChief Executive Officer, Director and

Chairman of the Board(Principal Executive Officer)Date: August 9, 2011
By:
/s/ Zedong XuZedong XuChief Financial Officer(Principal Financial and Accounting Officer)
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EXHIBIT INDEX





Exhibits:





Exhibit Number

Description

Method of Filing2.1

Agreement and Plan of Merger dated June 19, 2011, by and between the Company, Tech Full Electric Company Limited and Tech Full Electric Acquisition, Inc.

Filed as Exhibit 2.1 to the current report on Form 8-K filed with the Commission on June 20, 2011 and incorporated herein by reference.10.1

Voting Support Agreement, dated June 19, 2011, by and between Tech Full Electric Company Limited and certain stockholders of the Company.

Filed as Exhibit 10.1 to the current report on Form 8-K filed with the Commission on June 20, 2011 and incorporated herein by reference.10.2

Limited Guarantee dated June 19, 2011, by and between Mr. Tianfu Yang, Abax Global Opportunities Fund, AGC Asia 5 Ltd. and Prosper Expand Ltd. in favor of the Company.

Filed as Exhibit 10.2 to the current report on Form 8-K filed with the Commission on June 20, 2011 and incorporated herein by reference.31.1

Certification by the Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a)

Filed herewith as Exhibit 31.1.31.2

Certification by the Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a)

Filed herewith as Exhibit 31.2.32.1

Certification of the Chief Executive Officer and the Chief Financial Officer pursuant 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Filed herewith as Exhibit 32.1.




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